The charitable tax deduction and the arts

When is government not-taxing government spending?

Thomas Wolf has posted a short piece on the history of the National Endowment for the Arts, whether it is likely to survive the coming second Trump administration, and the tax deduction for charitable contributions. I’m going to focus on that last bit…

People who itemize their income tax deductions can claim contributions to registered charities. Wolf writes:

The U.S. government does play the role of support to many sectors including the arts and it does so at a much higher level than other countries by almost any measure. But in the U.S., the approach is overwhelmingly to let the private sector direct government funds through an extraordinary tax deductibility matching scheme.

It is worth remembering that while Americans do tend to be generous in their private giving, there are tax incentives in most rich countries for donating to the nonprofit arts. In my home and native land of Canada, we could make the case that the system is more generous, since it awards a tax credit rather than a deduction, but at the highest marginal tax rate, while in the US the value of the deduction is low for those people with lower taxable incomes and hence lower marginal rates. (Note this is a very worthwhile Canadian initiative - it solves the complaint we have in the US that the rich get a bigger tax refund than the poor do for making an equal dollar amount of contribution to charity, and it decouples the subsidy for charitable giving from the income tax schedule - the value of the credit can be set at any number we like, whereas in the US the value of the deduction is tied to the income tax rate schedule. I have been singularly unsuccessful at persuading anybody in the US of this, but I will keep trying).

Does the tax deduction matter for the amount of giving? Evidence says, yes, with an elasticity in the ballpark of -1. So: suppose Joe’s marginal tax rate is 30%, so that giving a $1 to the Springfield Symphony only really costs him 70 cents, if he claims the $1 donation on his tax form (he gives a dollar, but his taxes fall by 30 cents). Now suppose the marginal tax rate falls to 23%. Now giving a dollar to the Springfield Symphony costs him 77 cents (his taxes only fall by 23 cents for each $1 given), so the after-tax “price of giving” has gone up 10% (from 70 cents to 77 cents). An elasticity of -1 means that if the price of giving goes up by 10%, the average Joe’s amount of donations would fall by around 10%: if he used to give $200 per year to the Symphony, now he might give only $180.

Is this tax deduction “arts policy”? Not really. The tax deduction is for all charitable giving to registered nonprofits - hospitals, schools, social services, humane societies, and yes, the arts. I once wrote a paper on the fact that in the US, the UK, and Canada, even though they each subsidize charities slightly differently, they have in common that no distinction is made over the kind of charity: giving $100 to your local foodbank gets you exactly the same tax relief as sending $100 to your country’s most prestigious opera house (article in Cultural Trends here, if you don’t have access but would like to, as always, just send me an email).

What incentives this policy gives to donating money to the nonprofit arts is not decided by people thinking about the arts at all: it is the government thinking about marginal income tax rates, and reasons people have to itemize their income tax deductions.

Wolf notes that some people don’t like current arrangements, as they leave arts support to the decisions of wealthy donors rather than to public sector granting agencies (whether that is a good or bad thing is one on which people differ). But, he notes:

For those who don’t like the system, are they willing to give up more than $5 billion in annual indirect government support to the arts in the U.S. for a system of direct grants, even if the NEA’s budgets and those of state and local arts agencies were to grow ten times larger than what they are today? Such a system would leave more than $2 billion dollars of government arts support on the table.

But I’m not sure we can call the charitable tax deduction “government arts support.” (I’ll admit to having changed my mind on this a few times over the years…). The charitable deduction is government support only if we see it as a departure from an “ideal” tax system. But there is no ideal - the complex structure we have for taxing income is what it is, and there is no rationally pure way to say how taxable income ought to be defined (or whether income ought to be the basis of taxes at all, rather than, say, expenditures, or land, or, in the ludicrous fantasies of Mr. Trump, imports). If he cuts income tax rates (as he seems sure to do) then if we squint at a particular angle we could say “he just cut government arts support”, but I’m not sure I would put it that way.

In our numerical example from above, if the charitable deduction were ended, so that Joe’s giving $1 to the Symphony will cost him the full $1, and his marginal tax rate is 30%, then the tax price of giving has gone up by 43% (from 70 cents on the dollar to 100 cents on the dollar), and so his donations would decline by around that much: his $200 annual gift would fall to $114 (note this is my assuming the elasticity of -1 holds for all tax rates, rather than just for small changes, which is a thing I tell my students not to assume). Which is a big hit to be sure. But then you have other effects. Joe now has more disposable income. Or not if it gets eaten away by tariffs. He might shift to whom he gives his money. The government, other things equal, now has $60 more in tax revenue than it used to, since Joe isn’t claiming that $200 gift anymore. How will it use that money?