A Fine Mess
Page 9
Whatever the nomenclature, the annual reports from the Treasury Department and from finance ministries around the world make it clear that some of the rich democracies forgo large sums of potential revenue through tax preferences. On the personal income tax, a broad range of exemptions, deductions, credits, and so on reduce Great Britain’s tax revenues by 50% from what they would be without all those preferences. Italy’s revenues are 40.6% lower than they would be if all the credits and such were eliminated; in Spain, 34.6% lower; in Austria, 30% lower. In the United States, revenue is 37% lower than it would be without all the tax breaks. That means Congress could cut everybody’s tax rate by 37% and take in the same amount of revenue if we didn’t have all those tax expenditures.
For sheer creativity, the Italian income tax code is the world champion at inventing new credits. Like the United States and many other countries, Italy gives a tax deduction for paying the mortgage on your home. But the Italians also get a tax break for buying a home, renting a home, or renting an apartment for a child away at college. There is an income tax credit in Italy for “the annual subscription of children between 5 and 18 years old to gyms, swimming pools, and sporting clubs.” Any Italian who gets a salary or a pension from the Vatican is exempt from income tax. Italy gives a tax credit for life insurance premiums.5
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BUT THIS LEVEL OF tax expenditure is not a natural or a necessary aspect of a tax regime. Many developed countries—those that have broadened the base by eliminating tax expenditures—have minimal revenue losses. New Zealand’s income tax revenues are just 2% less than what they would be without any preferences. Denmark, Norway, France, and Germany are other countries that have a small revenue loss due to giveaways in the tax code. When these governments feel a need to provide subsidies to a particular group of people or businesses, the parliament passes a bill for a new spending program. That makes the whole process more transparent, it simplifies the tax code, and it means tax rates can be lower than they would be with a plethora of loopholes.
In the United States, the cost of tax expenditures is greater today than when Stanley Surrey’s blockbuster report came out in 1968. In fiscal year 2014, the total of tax preferences in the personal and corporate income tax came to $1.17 trillion, far more than any single government program. The breakdown looks like this:
Federal spending by program, 2014
Social Security
$845 billion
Medicare and Medicaid
$807 billion
Defense (including Afghanistan)
$696 billion
Civilian departments and agencies
$582 billion
Tax expenditures
$1,169 billion
Source: Office of Management and Budget, Budget of the United States, Fiscal Year 2014, Historical Tables 8.5
The United States offers tax breaks for contributing to charity, taking a night-school course, paying local property tax, growing sugarcane, moving to a new city for a job, replanting a forest, insulating the attic, paying off a mortgage, destroying old farm equipment, employing Native Americans, commuting to work by bicycle (but only for a bike that is “regularly used for a substantial portion of travel,” whatever that means),6 or buying a plug-in hybrid sports car. Congress’s Joint Committee on Taxation counts more than two hundred separate tax expenditures.
Because many of these giveaways replicate the kinds of benefits provided by governments in left-leaning European countries, tax expenditures have been called America’s “hidden welfare state.” That is, we give people welfare through the tax code even when we aren’t willing to provide the same kind of support by sending a welfare check.
When our family lived in Great Britain, we received a check each month from the government for something called “child benefit.” We still had two kids under eighteen then, and we got about $100 per month for each of them. They pay you just to have children! That sure seemed like the European welfare state to me; can you imagine the U.S. government sending welfare checks to an upper-bracket family like ours just for having kids? In fact, we do—through the tax code. An American taxpayer gets a tax exemption for each dependent child under eighteen (plus any child over nineteen who is still a student); in 2016, it was $4,050 per child. For me, the tax saving I got in the United States from the exemption was just about the same amount as those “child benefit” checks I got in Europe. (Beyond that exemption, there’s also a “child credit” provision that cuts the tax bill by $1,000 per child for many American families.)
Following Stanley Surrey’s example, the Treasury Department reports each year on how much revenue is lost due to each specific tax break. This annual report is a long and nearly impenetrable document that seems designed to make the information as opaque as possible. In its 2015 report, Treasury listed 169 specific tax breaks, including “Exclusion of interest on life insurance savings” ($17.1 billion), “multi-period timber growing costs” ($360 million), and the “Indian Employment Credit” ($30 million). But the report does not bother to show the total cost of all these giveaways; the department’s explanation is that the law requires a “list” of tax expenditures but not a “total.” (As noted above, if you add them all up, they total about $1.17 trillion.) To complicate things further, the congressional Joint Committee on Taxation issues its own yearly report on tax expenditures, with figures that are different from the Treasury’s in many cases.
Every year, the number one exemption is the rule that says the premium your employer pays for health insurance is not counted as taxable income; for 2016, the Treasury Department said, this would cost the government $216 billion. The economists say this makes no sense; paying an employee’s insurance premium is the same thing as paying an employee’s wages and should be taxed the same way. Other countries that have private health insurance companies generally do not allow this tax exclusion. In any case, health insurance is so much cheaper in the other developed countries that exclusion would amount to a fairly small revenue loss. It’s only the United States that adds $200 billion to its deficit every year through this tax break.
After that huge one, the major tax expenditures in the Internal Revenue Code involve deductions for homeowners, tax breaks for retirement savings, the decision not to tax corporate profits that are held overseas, and the deduction for charitable contributions.
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TO BROADEN THE BASE and lower the rates, we have to get rid of these costly expenditures. It should be easy to go after hard-to-defend tax breaks like the credit for buying a $105,000 sports car or for destroying an obsolete tractor. There are dozens of these loopholes in the code that could not be justified if they were proposed as outright spending programs. Unfortunately, most of the obviously stupid tax expenditures involve a relatively small loss of revenue. If we’re going to make any serious headway against the avalanche of giveaways in our tax code—so that the rates can be cut—we will have to get rid of some of the biggest and best-liked tax deductions as well.
Probably the most popular tax break in the Internal Revenue Code is the deduction for charitable contributions. Everybody likes the idea of rewarding people for being generous. You give money to a charity; you deduct that amount from your income; you end up paying less tax. The charity gets money it needs for good causes; the taxpayer saves some money on April 15. The downside is that government takes in $50 billion less revenue every year. (It’s possible, though, that the charitable contribution might also save the government some money, by funding a public purpose that would otherwise be left to government.)
This deduction probably matters more to Americans than anybody else because we give more to charity than the citizens of any other country. And the
United States has more officially recognized charities—that is, organizations that earn a tax deduction for their contributors—than any other country. The Chronicle of Philanthropy says the number of different organizations eligible to receive tax-deductible contributions is over one million; in other countries, the number tends to be a few dozen.
At first blush, the notion of encouraging people through the tax code to give to charity seems as pure and sweet as mother’s milk. But the whole idea turns sour when you look at it closely; that’s why more and more developed countries have sharply limited this deduction or dropped it altogether.
One major sore point is that the charitable deduction is a deduction and thus saves far more for upper-bracket taxpayers than for the average worker. If a woman so rich that she is taxed at the top rate (39.6%) gives $100 to her church, that gift will reduce her tax bill by $39.60. A woman at the medium income, paying tax at a rate of 15%, will save only $15 for the same $100 contribution. This is the problem Professor Surrey used to illuminate for his students: “The unfairness of the deduction in its favoritism for upper bracket taxpayers is . . . evident.”
But that’s not the only problem with the deduction for charitable donations:
—Most people who give to charity get no deduction for it. To take advantage of the charitable deduction, you have to fill out the IRS form for “itemized deductions.” But only about one-third of all taxpayers use this form. The majority of taxpayers just take the standard deduction, which gives you the same deduction whether or not you give money to charity. Therefore, most people get no tax benefit for giving to charity. The millionaire who gives enough to get her name on a dorm at her alma mater gets a big tax break, while the median-income mom who gives $50 to the local PTA gets none.
—The most common forms of charity don’t qualify. In a nation of churchgoers, putting cash in the collection plate at weekly services is probably the most common way people give money, along with giving a homeless panhandler a dollar or dropping $5 into the pot to help fund the school baseball team. But these familiar acts of charity will not get you a tax deduction. Cash contributions don’t count.
—It’s widely abused. If you write a check for $100 to the Boy Scouts, or give an old car to the public radio station, these contributions are easy to value. But the richest taxpayers often make charitable donations with a cash value that is hard to determine—land or buildings or works of art. The most common problem here comes in gifts of paintings or sculpture to museums. To determine the value of the contribution, the donor or the museum often turns to an “independent” appraiser. The appraiser’s fees are paid by the donor or the museum. And the appraiser knows, of course, that those who pay her fee want to claim the highest plausible value; that way, the donor gets the largest possible tax deduction, and the museum can boast about its fabulously expensive new acquisition.
This situation is abused so frequently that tax collection agencies around the world have had to set up their own appraisal offices; in the United States, the IRS has the Office of Art Appraisal Services and the Art Advisory Panel. In about two-thirds of the cases it reviews, the IRS finds that the donated work of art is worth significantly less than the donor’s appraisal. That finding, in turn, often leads to an extended and expensive battle in court.7
In addition to excessive valuations, donors of artworks have devised various stratagems that let them take the deduction without actually giving up the art. One gambit is called fractional giving. This means that you give the painting to a museum for a fraction of the year (maybe for three months, while you’re at your summer home in the South of France), take a tax deduction for this contribution, and then put the painting back in your living room. Congress cracked down somewhat on this scheme in 2008. That reform prompted rich donors to create a different dodge: the “private museum.” This means you build a museum next to your house, sometimes way out in the country, with no sign on the door. You give your art to this “private museum” and take a tax deduction—for giving art to yourself. The Glenstone museum, for example, has provided its founder with major tax deductions since it was created in 2006. It is situated on the estate of its owner in Potomac, Maryland, with a gate and a guardhouse to protect the privacy of the collection.8
—It’s not easy to define a “charity.” When Congress wrote the law setting forth which organizations qualify as charities, it threw in everything but the kitchen sink. If any group’s activities are “religious, educational, charitable, scientific, literary, testing for public safety, to foster national or international amateur sports competition or prevention of cruelty to animals,” it qualifies. Some of the outfits to which contributions are tax deductible are one-room soup kitchens run by volunteers in the church basement; others are huge and highly prosperous organizations. Your gift to Harvard University, for example, is treated as a deductible contribution to “charity,” even though Harvard is sitting on an endowment of $37 billion and earns more than $1 billion each year in the securities markets.
The IRS rules list twenty-eight different forms of “exempt organizations.” Some are eligible for tax-deductible contributions; some are not. If you send money to the Heritage Foundation, a Washington, D.C., think tank that advocates conservative policies, that’s deductible, but if you send money to Heritage Action for America, an organization that has the same address and campaigns for the same conservative policies, that’s not deductible. Keeping track of which organizations are really charities, and which ones are actually business or political operations masquerading as “social welfare” operations, is a full-time job for several hundred IRS staffers. The designations change so often that the IRS finally had to stop printing its list of authorized charities and switch instead to an online document so that it could be updated daily.9 Because Congress, as usual, failed to make clear distinctions in the laws it wrote, the task of distinguishing charities from non-charities falls to IRS bureaucrats. This became the subject of angry political uproar in 2013 when it was charged that IRS staffers were singling out Tea Party groups for extra scrutiny when they applied for tax-exempt status. To avoid future controversies, the IRS today grants “exempt” status to 95% of all the groups that apply for it.10
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ALL THOSE ISSUES SHOULD be enough to demonstrate that the deduction for charitable contributions is costly, unfair, and easy to abuse. But there’s actually a more fundamental problem with this particular deduction: It doesn’t work. Although it costs governments a lot of money in the form of reduced revenues, it doesn’t do what it is supposed to do.
The purpose of this deduction is to encourage people to give more and thus increase the money available for charity. But there’s no evidence—no studies, no data—that shows people contribute more because of the tax deduction. In the United States, the last few decades seem to show the opposite. When tax rates go up—which makes the deduction more valuable to the giver—contributions stay about the same. When tax rates go down—so that each contribution is less valuable on Tax Day—contributions stay about the same. With the big 1986 tax cut, the top rate fell from 50% to 28%. This made a contribution far less valuable in tax terms, and many charitable groups predicted a disastrous drop in donations. In fact, the effect was minimal. Contributions dropped slightly for a couple of years after the 1986 rate cut and then started going up again.
Still, the politics of eliminating the charitable deduction can be difficult. Here, too, we can learn from other nations. Most developed democracies that used to allow a full deduction for gifts to charity have sharply curtailed or eliminated this problematic tax break.
One common approach is to put a limit on how much any taxpayer can write off for charitable gifts in a single year. The United States has such a limit; generally, people can deduct no more than 50% of their income for contributions. Other countries have made the limit stricter. In much of Europe, the total of deductible contributions can’t exceed 20% of income, which means a muc
h lower loss of revenue; in the Netherlands, the limit is 10%. To deal with Professor Surrey’s “unfairness” problem—giving the rich a bigger write-off than average earners who contribute the same amount—some countries (for example, Canada and France) give a tax credit, rather than a deduction, for contributions. Most developed countries have a much tighter definition of what constitutes a “charity” that is eligible for deductible contributions. The U.S. roster, more than a million approved charities, runs for scores of pages on the Internet; Japan’s entire list of eligible charities fits on one side of one sheet of paper. Japan also gives a tax deduction for contributions to government agencies, but that list is also fairly short.
The best way, though, to avoid the unfairness, the abuses, and the revenue loss from the charitable deduction is to get rid of this deduction altogether. Austria, Finland, Ireland, Italy, Sweden, and Switzerland all have flourishing charity sectors, even after they took away the tax break for contributions; New Zealand, of course, got rid of it in that first base-broadening exercise in the 1980s. None of these countries saw any significant drop in charitable contributions. All over the world, people contribute mainly because of a belief in a particular cause or because of a basic human desire to help others. Getting a tax break is, at most, a minor motivation. The tax deduction for charitable contributions cheapens the charitable impulse by implying that you and I wouldn’t give a dime to charity unless we got a little financial gain on the side.