An earthquake just hit the nation: the new Republican tax bill. It will take months and years to sort through the ramifications and debris. There are huge implications for the economy, for the wealth divide, and for the healthcare system.
But I’m going to focus on the probable impact on the nonprofit world – and it’s really bad.
Here’s what I think will happen.
Financial incentives to donate to charity will drop dramatically.
You can only deduct a charitable gift if you itemize your deductions. That means that only the 30% of taxpayers who currently itemize their deductions receive any subsidy from the federal government for donating to charity.
If you itemize, and you give $1,000 to charity, you can subtract or deduct that $1,000 from your taxable income. So if you’re in the 20% tax bracket, you save $200 on what you owe in taxes, and the $1,000 gift really only costs you $800. (It costs you even less if the gift is made with appreciated stock, but we’ll hold off on that detail for now.) On the other hand, if you don’t itemize your deductions, the charitable gift does not save you a penny on your taxes: for non-itemizers a $1,000 gift actually costs $1,000.
I have written before about how unfair it is that only the taxpayers who itemize their deductions, and who more or less are the wealthiest people in the country, can claim this charitable subsidy, while less well-off people get no subsidy whatsoever for their charitable gifts. Moreover, among those who itemize their deductions, the richer you are (and the higher your tax bracket), the more generously the government subsidizes your charitable giving.
In any case, thanks to the new tax bill, there will be far fewer itemizers, and many fewer people who will have an incentive to contribute to charity.
That’s because the new tax bill doubles the standard deduction for tax filers to $12,000 for individuals and $24,000 for married couples. Consequently, the number of people who will itemize their deductions will likely drop from 30% to only 5% of all taxpayers – which means that for 95% of all taxpayers, there will be no deduction, no subsidy, no encouragement whatsoever through the tax system to give to charity.
Or to put it another way: going forward, 19 out of 20 taxpayers will receive no tax benefit by giving to charity.
Will people still give? Of course. But will they give less? Certainly. Incentives matter. And there’s also been a helpful misunderstanding among donors that may have encouraged gifts even from the 70% of the population who haven’t been itemizing. The mantra of “your gift is tax deductible” has been so omnipresent in American culture that many people who were getting no actual tax break somehow seemed to think that they were.
Now, that illusion is over. Under the new guidelines, it will be evident to all that only the 5% at the top of the pyramid will benefit from a charitable deduction. The presumption will now be that there is no subsidy for giving to charity. Fewer donors will give, accelerating a trend whereby the percentage of middle-class families donating to charity has dropped considerably in recent years.
This is a significant departure from the understanding we’ve relied on for the last century.
In every developed nation, government takes responsibility for ensuring the public good. Governments provide roads and transportation, a functioning judicial system, a stable currency, police and fire protection, national defense, and the legal and physical infrastructure to make commerce and day-to-day life possible. In responsible nations, the public good also includes ensuring that citizens can receive medical care, education, food, shelter, and support in times of emergency.
In most parts of the developed world – certainly in Europe, and most obviously in Scandinavia – the government directly funds these services and often actually owns and runs the institutions. Taxes are very high in Denmark, for example. But Danish parents don’t have to pay for childcare, Danish students don’t have to pay for college, Danish patients don’t pay for healthcare, and virtually everyone in Denmark retires with a pension large enough to live on. That’s the European social welfare state model.
Here in the more individualistic United States, we have done things very differently: we developed a hybrid model for basic services. Less than in other developed countries, government in America provides relatively little direct funding for health, education, and social services. Rather, we have encouraged a robust charitable sector that, far more than in Europe, delivers the core services upon which society depends.
In America, if you get sick, the ambulance will likely take you to a nonprofit hospital. When our children go to pre-school or college, they likely will be attending nonprofit institutions. Even most state universities derive only a small percentage of their revenue from taxpayer dollars. In the U.S. charitable organizations carry out work that in Europe is paid for and often delivered by government.
And part of why this arrangement has worked fairly well is that, for the last 100 years, government has supported the charitable sector by providing a charitable deduction from income taxes. The federal income tax came into being a century ago largely as a way of funding the military build-up before America’s entrance into World War I. It was less than a year later when Congress, worried that core services like hospitals would lose their philanthropic support, instituted the charitable income tax deduction. The government explicitly wanted to encourage gifts to charity as a way of supporting critically important organizations.
It’s a model that has worked for a century. Now – thanks to the new tax bill – the historic way of funding American charities has been torn asunder.
There will be fewer charitable bequests.
According to Giving USA, charitable bequests accounted for eight percent of all giving last year. I don’t know how much of that giving was driven by a desire to minimize estate taxes (dead people are notoriously difficult to survey), but it’s a fair assumption that a significant portion of charitable bequests came about in part to avoid estate taxes.
Estate taxes only apply to the very wealthy: individuals with estates worth over $5.5 million. Under the new tax bill, that $5.5 million “exemption” will now be doubled to $11 million, meaning that only couples worth more than $22 million will owe estate taxes. This reduces the number of families subjected to the estate tax to a miniscule number, and now only those super-wealthy families will have a financial incentive to contribute to charity. (As recently as 2001, the exemption was $675,000 – which is to say, the exemption has increased by nearly 1,530% in only 17 years.)
Experts claim that these two changes in tax law – doubling the standard deduction for income taxes and doubling the estate tax exemption – will cause over $20 billion of charitable giving to disappear next year. That’s not a small amount of money for a charitable sector that’s barely getting by.
And that’s not all.
More and more giving will go to donor-advised funds.
My regular readers are aware that I’m very concerned with the growing share of charitable giving garnered by donor-advised funds (DAFs) – and the light regulations that allow those funds to go undistributed for years on end. (Click here for my most recent analysis.) But I can tell you with confidence that the share of money going into DAFs in 2017 will break all records – and that an increasing portion of the donor population will be relying on donor-advised funds as a way to manage their tax obligations.
The rush to donor-advised funds is partly because Wall Street DAF sponsors have been putting on a full-court press for months, playing on their clients’ insecurity about tax changes. For example, this fall about 500 or so Morgan Stanley financial advisors sent out an identical tweet, reading: “Take advantage of an immediate charitable tax deduction by contributing to a donor advised fund. Ask me how!” with a link, of course, to the Morgan Stanley DAF page. (Note that the tweet makes no mention of charitable impact. Charity, for the commercial DAF industry and many of its clients, is merely a by-product of tax planning.)
Now that the GOP tax bill has actually been passed and signed, financial advice columns, like this one from The New York Times, suggest that donors “bunch” their charitable giving – providing, say, $30,000 in charitable gifts in Year One (and itemizing that year’s deductions) and giving no charitable gifts at all in Year Two (while taking the standard deduction) – and continuing to alternate their charitable giving year by year. That’s a terrifying notion for nonprofits. If many donors are so truly driven by tax considerations that they adopt this feast-or-famine approach, it could be enormously stressful to nonprofits, whose expenses, of course, do not fluctuate significantly from one year to the next.
The Times column further suggests an alternative to the bunching of charitable gifts: creating and adding to donor-advised funds in 2017 and in future years of high earnings, and then distributing the proceeds to charity. This would be fine, actually, if charitable distributions went out strongly, quickly, and consistently from DAFs. The Times story notes that donor-advised funds are “not without controversy,” especially as “there is no firm requirement for the funds to actually pay out the money within a certain period.” Well, that’s an enormous understatement, because there is no requirement for the funds to pay out anything, ever. That’s at the heart of the critique of donor-advised funds, and that’s why I am among those reformers calling for DAF assets to be paid out in full within a set number of years of contribution.
But that spend-down requirement for DAFs remains theoretical, and the flood of money into donor-advised funds is hugely problematic. The bottom line is this: If people respond to the new tax law by tossing assets into donor-advised funds, and many of those funds are largely inactive, the charitable world will take an enormous hit.
Confusion and anxiety may reduce giving.
Many fairly wealthy people, particularly those who live in states such as New York, New Jersey, California, Massachusetts, and Connecticut with high real estate values and high local and state taxes, may see their federal taxes rise considerably. That’s because the new bill limits how much of their state and local taxes (SALT) and mortgage interest they can deduct. These provisions are causing great anxiety among what I’ll call the “merely wealthy,” and that anxiety may well translate into lower charitable giving.
After all, someone living in New York City may have what most of us would see as very high income, but if she now is anxious about paying $20,000 or $30,000 more in federal taxes than in years past, she’s not going to be nearly so likely to write a big check to charity. And this person will certainly be hesitant about making contributions until she gets through the first cycle or two of the new tax regime.
This anxiety has not been factored into the projections I’ve read relating to the impact of the tax bill on charitable giving. I’m guessing that the situation may be even worse than the experts claim. I hope I’m wrong. But as I hear from wealthy and panicky friends in New York and California, there’s a genuine sense of unease. These folks suddenly feel financially stressed and unsure. People feeling a sudden financial anxiety are likely to reduce their charitable giving, even if, from the outside, they appear to have plenty of money.
Plutocrats will rule charity – even more than now.
A year ago, a report called “Gilded Giving,” made a big splash. It described how an ever-larger share of charitable giving is being contributed by an ever-smaller portion of the population. That trend will accelerate thanks to the new tax bill. Middle-class people were already abandoning charitable giving. The only people left with a financial incentive to give will be those in the top 5%. And by all accounts, people in the top 1% will reap enormous savings from the tax bill and presumably have more to contribute than ever before. As a result, more and more money will be given by fewer and fewer donors. What used to be the 80/20 Rule (where 80% of the contributions come from 20% of the donors) long ago became the 90/10 Rule, or, by my observation, the 95/5 Rule. I think we’re heading for the 99/1 Rule.
What’s the matter with that? Well, when a handful of people determine the charitable priorities of a nation, it’s fundamentally undemocratic. Yes, billionaires should be honored for their generosity. But many of these gifts carry an agenda. The Walton family (of WalMart) have largely funded the school choice movement for years, significantly affecting American educational public policy with their charitable grants. Bill and Melinda Gates oversee the largest foundation (by far) in the world, and they make their decisions with a board of three: themselves, plus Warren Buffett. That’s enormous power to be vested in only three people. I find it remarkable that in most states a tiny small-town historical society requires a minimum of five unrelated board members to be legal, but the largest foundation in the world can be overseen by a married couple and an octogenarian pal. I don’t have anything against Bill, Melinda, and Warren, but their success in the business world should not entitle them to such unbridled power in the charitable world. Moreover, I have to think that three of the richest people in the world, no matter how well-intentioned, are more than a bit removed from the day-to-day challenges of the average family.
We can’t un-elect the Gateses and Warren Buffett from their leadership of the Gates Foundation. And their influence is vast. Bill Gates is often referred to as the unofficial and permanent Secretary of Education. That’s not good for a democratic society. It’s not healthy for the country. But, with the new tax bill, we’re going to get much more of that concentration of philanthropic power among the super-wealthy.
More and more of the charitable community is now viewed through a political lens.
These are the most partisan political times in America since the Civil War. And charities are being pulled into the fight.
The tax bill showed that now even universities are viewed in a partisan context. The federal government will now tax large university endowments — an extraordinary turn of events. Know that I am not an unqualified fan of how universities have managed their large endowments. I have long urged universities to increase their spending rates and put their funds to more immediate use. (That was actually the topic of my first-ever blog post in this space, nearly six years ago.) But I was encouraging universities to spend more from the endowment to fund current scholarship and research. I wanted them to meet the current educational needs, rather than hoarding the money for the future. The notion of depleting the endowment to pay taxes was beyond the realm of my imagination, or of what most objective observers would deem appropriate.
But the Republican Congress, in this hyper-partisan climate, sees elite universities as bastions of liberal thought. These members of Congress consequently consider universities as ideological enemies to be humbled. The new tax on large endowments takes a swing at universities – even though American higher education is one of the few places in the world where the United States has maintained its preeminence, and even though universities have given birth to many of the cutting-edge technologies and businesses that the tax plan supposedly wants to support.
Another shoe, or two, or ten, dropping in 2018
The tax bill is estimated to ratchet up the national debt by $1.5 trillion in the next decade. (I’m guessing it will be more than that, once taxpayers and their accountants begin to take advantage of the gaping loopholes in this rushed bill, and once they recognize that the ever-less sufficiently funded IRS will have little ability to catch tax cheats.) I would say that the Republican Congress is spending money like drunken sailors, but that would be unfair to drunken sailors.
It’s my guess, and that of many observers, that after January 1 Congress will suddenly change course and begin to adhere to a strict code of fiscal temperance. They will express concern about the deficit, and they will start trimming the budget. They will declare that they can’t afford to restore funding to CHIP, the (until now) very effective health insurance program for nine million children of working-class parents. They will trim funding for domestic spending. They will shrug their shoulders and shake their heads, grins on their faces, as 13 million people slip off the Obamacare health insurance rolls. They’ll cut funds for Medicare, Medicaid, and Social Security. In these and dozens of other ways, Congress will exacerbate educational, social, health, and environmental problems in the country. And the responsibility for meeting the resulting problems will fall to – you guessed it! – the nonprofit community.
It’s a perfect storm: As government cuts domestic funding and reduces entitlements, nonprofits will be called on to pick up the slack. Meanwhile government tax policies will undoubtedly reduce charitable giving, undermining nonprofits’ ability to carry out their work.
This is, yes, a grim overview of the scene — but an honest one. The charitable sector has become collateral damage of the hellbent Republican effort to please what appear to be their most important constituents: billionaire political donors, major corporations, and K Street lobbyists. Certainly those folks will be having a good holiday.
For the rest of you, you’re right to worry. May the time off in the next week prepare you all for a very tough year to come.
Copyright Alan Cantor 2017. All rights reserved.