If you have a tax, should you have a tax credit?

by Fred E. Foldvary

The federal government budget proposed by the president imposes higher taxes on incomes above $250,000. One of the provisions is that charitable donations would no longer be tax deductible.

As the tax code is now written, it takes $100 of income to donate $100. Suppose the tax rate is 50 percent. The tax would take $50, leaving the taxpayer with $50. But if he donates the $100, his taxable income is reduced by $100, so there is no tax on the donation. It takes $100 of income to give $100 of donations.

Now suppose that the tax deduction is gone. The taxpayers would like to donate $100. He now has to earn $200 to donate $100, since half the $200 of income will be taxed away.

Without a tax deduction, charitable donations get tax punished. When the beneficiaries of donations are the poor and other good causes, these suffer from fewer gifts. A tax on charitable donations hurts the homeless, the hungry, the wildlife that does not get preserved, the ignorant who do not get educated, and all humanity which loses knowledge and more of its natural legacy. When government taxes the rich like this, it taxes the poor.

Advocates of taxing contributions say that donors are motivated to give, and so would donate regardless of the tax. But the law of demand applies to the rich as well as the poor. If something is more costly, people do less of it. If it is more costly to donate, there will be less charity. One does not become rich by not caring about money.

If the purpose of taxing donations is to squeeze more money from the rich, there are better ways to do that. The government could charge the wealthy for the use of other people's property. If a rich guy pollutes the environment, he is using resources that do not belong to him, so he should compensate society for that use. But no, the polluter gets subsidized while the donor gets penalized.

The administration says that they will require polluters to buy permits. But the sale of permits is planned as a one-time deal. After that, if the price of permits rises, the permit holders will profit. The polluters will pay the permit holder instead of compensating society. Moreover, many polluters, such as vehicles, will not have to hold permits.

Governments at all levels also subsidize the rich by increasing the value of their land. Public goods such as streets, highways, transit, parks, schools, fire protection, security, and water all make the affected land more attractive and productive. Up goes the rent and land value. If the landowners had to pay for these services, that would bring the price of land back down. But since most of the cost is paid by taxes on labor, enterprise, and goods, the land value stays up.

So government with one hand taxes the income of the rich while on the other hand gives back the wealth. But the method of tax and give-back matters. It makes a difference whether government says, "give me $100" or "give me $100 only when you donate to charity." In the second case, there will be less donation to charity.

The best policy would be to not have the subsidies in the first place. Polluters would have to compensate for their dumping, and landowners would have to pay to have their sites serviced. That's what would happen in a truly free market. Today we have distorted markets in which people get punished for doing good things such as producing goods, while they get subsidized when they do bad things such as spewing pollution.

Now the administration seeks to make that worse by punishing acts which do the most moral good. By natural moral law or the universal ethic, it is morally good to benefit others. And now government will swoop down and punish acts that benefit others. Punishing donations is evil in two ways, once by imposing an extra cost for doing good, and secondly by depriving the needy from the aid they would otherwise get.

Evidently the administration is proposing this tax on charitable donations expecting Congress and the people to think this is a good policy. Will Americans go along with this? Has everybody gone crazy? If you ever wonder how the world has gotten into such a mess, ponder how can the economic gurus of the government could come up with something as absurd as taxing charity for the poor.

This article first appeared in the Progress Report, www.progress.org. Reprinted with permission.

Dr. Fred Foldvary teaches economics at Santa Clara University and is the author of several books: The Soul of Liberty, Public Goods and Private Communities, and the Dictionary of Free-Market Economics.