Michael Hicks is the George and Frances Ball Distinguished Professor of Economics and the director of the Center for Business and Economic Research at Ball State University. His column appears in Indiana newspapers.
The passage of the Tax Cuts and Jobs Act has many not-for-profit firms concerned about the laws impact on charitable giving. Part of their concern is based on a study released last May by the Lilly School of Philanthropy, which concluded that lowering the top tax rate and increasing the standard deduction would reduce charitable giving by 4.6 percent. This study was a thoughtful, transparent and timely contribution to understanding policy effects on charitable giving. However, both the passage of time, and some issues this study team did not address warrant a bit of reflection, which ought to ease the worries of humans in the not–for-profit world.
The Tax Cuts and Jobs Act doubled the standard deduction and cut the tax rate for the vast majority of taxpayers. This does two things immediately that are of interest. First, it reduces the tax savings from charitable donations, effectively raising the ‘price’ of giving. This was the focus of the IU study. Second, it increases real disposable income due to lower tax rates. Combined, economists call these the price and income effects.
The IU study estimated the price effects at about 4.6 percent of charitable giving. I think that estimate is useful, especially since there tends to be a shift between types of charities, a difference between the short-run and long-term response, and a fairly wide range of estimates of donor response to tax changes. Moreover, high-income households, who donate the most to charities, see the smallest impact on the price of donating. The IU study did a good job dealing with these issues, but altogether this means there is a great deal of uncertainty about the ultimate size of the impact.
However, depending on which assumptions are used, the tax cut passed last month will also result in an increased tax savings that should result in an increase in charitable giving of between 2.5 and 4 percent. This partially offsets the price effect. But there is more to the story.
The Tax Cuts and Jobs Act does two other things worth noting. First, it should increase economic growth modestly, adding between 0.1 and 0.4 percent to the economy each year. Second, it should reduce the demand for private social services as the economy grows, and so personal income rises and the demand for labor increases.
If the tax cuts lead to this additional economic growth, that would increase disposable personal income, which should yield growth in charitable donations of between $2.2 billion and $8.8 billion, which is unsurprisingly between 0.1 and 0.4 percent of charitable giving. Space does not allow for an estimate of the lessened demand for services. But there is still more.
In 2014 the IRS reported $213 billion in charitable donations, but Giving USA reported that Americans gave $358 billion that year. That means that less than 60 cents out of every dollar of charitable donations is reported to the IRS. Moreover, the real share of un-deducted giving is probably much higher since the IRS allows some pretty questionable deductions (recall Bill Clinton’s $15 skivvies). Probably a half of all charitable deductions are unaffected by tax laws today. So, taken altogether, it appears that the Tax Cuts and Jobs Act is most likely to have no noticeable effect on charitable donations in 2018, especially for individual charities who are accustomed to large annual changes to donations. But, yes, there is even more to the story to warm the hearts of American charities.
Since the end of the Great Recession, the link between charitable giving and overall disposable personal income has been shattered. Prior to 2007, increases in income led to increased charitable giving. Since 2009, inflation-adjusted charity deductions have risen by 21 percent, while disposable personal income has dropped by 1 percent. Indeed, the rate of charitable giving since the end of the Great Recession would more than offset the effects of the Tax Cuts and Jobs Act. All in all, American not-for-profits should expect an increase in charitable giving this year, with or without the Tax Cuts and Jobs Act.