An Obama Tax Proposal That's Easy For Me to Support

President Obama has made very few policy proposals that I can support and many that I strongly oppose. However, when President Obama does make a good proposal, people who regularly oppose him should be principled and intellectually honest enough to acknowledge that fact and support the proposal. So I come today to praise President Obama's proposed reform of the tax treatment for charitable deductions. If Congress does implement tax reform, this proposal should be part of the reform.

Currently tax filers who itemize their deductions are eligible for federal tax deductions for charitable donations along with deductions for state and local taxes, medical expenses above a floor of 7.5% of income, unreimbursed business expenses above a floor of 2% of income, and mortgage interest payments. People whose total deductions are less than the standard deduction do not itemize, so they get no tax benefit from charitable donations (since a minimum level of tax deductions is granted to everyone, earned or not).
The key feature of the current system that is at issue is that people in higher income tax brackets get a bigger "discount" on their charitable donations because their higher tax rate translates into larger tax deductions from the same size charitable donation.

To make this concrete, imagine two families, both who have other deductions at least equal to the standard deduction. If a family in the 15% bracket makes $10,000 in charitable donations, they save $1,500 on their taxes, so the donations only cost them $8,500 in after-tax income. A family in the 33% bracket who makes the same $10,000 in donations will save $3,333 in taxes, so their net cost is only $6,667.

Does it make sense to make charitable giving easier for higher income families and relatively more expensive for lower income families? This is one of the only features of the U.S. tax code which is regressive rather than progressive, meaning it gives richer people a tax advantage compared to poorer people. I personally think the tax code is too progressive at the moment, but that does not mean lower income people should be treated unfairly by the tax code when they make charitable donations.

President Obama has proposed equalizing the tax treatment by providing all taxpayers with a nonrefundable tax credit equal to 25% of charitable donations. That would provide a slightly smaller tax break for people in the top few brackets and a larger tax break than they currently receive for around 90% of all Americans. This new policy is similar to a flat tax because everybody gets the same percentage tax credit.

A report by the Congressional Budget Office has analyzed a set of proposed changes to the charitable donation tax policies and found that President Obama's proposal can be made a win-win with a small adjustment. If a floor is added to the credit, allowing the 25% credit for all taxpayers on charitable donations above $500 for individuals and $1,000 for couples, total charitable donations would actually rise slightly and the total of tax breaks provided declines slightly.

According to the CBO's estimates, charitable donations would rise by $1.5 billion, from $203 billion to $204.5 billion. At the same time, the tax breaks provided would drop from $40.9 billion to $38.5 billion, actually helping reduce the federal deficit by $2.4 billion.

Thus, a slightly modified version of President Obama's proposal would achieve three positive effects. First, the tax treatment of charitable donations becomes more equitable across income levels. Second, the proposed change in tax treatment would not hurt charities, since total charitable giving is essentially unchanged, with CBO even predicting a slight rise in giving. Third, because the total tax breaks provided by the federal government in response to these donations goes down by $2 billion, the change will actually provide a little bit of deficit reduction.

Possible and already-voiced complaints about the proposal are several. First, some conservatives may complain that because the total of tax breaks declines, the policy change raises net tax revenue slightly. However, a better way to look at this is that under the new policy, slightly more charitable donations will be made with less interference from the government in the charitable marketplace. Conservatives should be supportive of reducing government distortions in markets that don't need it. Supporters of various flat tax proposals should also favor the introduction into the tax code of proportional treatment of charitable donations as a way to get their toe in the door.

Charities are not surprisingly wary of the policy change. Although the CBO report predicts total giving will not be harmed by the new tax treatment, there is much uncertainty among economists and people who work in philanthropy about the impact of changes in the level of tax deduction on giving, particularly among higher income people. Certainly, charities may want more study and can be expected to be cautious. However, CBO has relied on the best available estimates of behavior and while their predictions are not infallible, they do suggest that whatever the effects of the policy change are, they are unlikely to result in large changes in charitable donations or tax collections.

Republicans may not want to agree with President Obama. However, the policy makes sense and people who find the policy change to be positive should support it regardless of who proposed it. Republicans would probably find greater public support for their opposition to so many of President Obama's policies if they showed they could agree with him on those occasions when the opportunity presents itself.

Committees in the House and Senate are working on comprehensive tax reform this year. It is unclear if tax reform will really happen. If Congress does make progress, a change in the treatment of charitable deductions should be part of any reform. President Obama's proposal for a uniform, nonrefundable 25% tax credit with the addition of a floor of $500 for individuals and $1,000 for joint returns will provide more equitable treatment for all American's charitable deductions without hurting charities or the deficit. This should be a policy change that everyone can support.