Tax Incidence

One thing students in public finance courses learn is that who you levy a tax on isn’t always the person who pays the tax. For example, suppose you place a per unit tax on hamburgers and make the burger restaurant responsible with paying the tax. What does the burger restaurant do? Raise its price by $1. But does that mean the consumer pays the full burden? No. Why? People will consume fewer burgers. As such the $1 tax is actually split between the restaurant and the consumer. The exact level of the split is determined by the elasticities of supply and demand with respect to price.

In regards to Obama’s proposal to limit the deductibility of charitable giving Martin Feldstein makes essentially the same point,

President Obama’s proposal to limit the tax deductibility of charitable contributions would effectively transfer more than $7 billion a year from the nation’s charitable institutions to the federal government. But the high-income taxpayers affected by the rule change are likely to cut their charitable giving by as much as the increase in their tax bills, which would, ironically, leave their remaining income and personal consumption unchanged.

In other words, it wont be the rich who pay the taxes, even though they have the statutory burden, it will be the charities and those these charties help that will be bearing the burden.

The proposed tax change would apply to married couples with incomes of more than $250,000 (and single people with incomes greater than $200,000). Under current law, such couples can deduct the value of their charitable gifts from their taxable income. While no one makes a charitable contribution to get a tax deduction, the deductibility of charitable gifts reduces the cost of giving and therefore increases the amount that individuals give.

Well, that looks like it is more of the “tax the rich” thinking. I think it is time for somebody to tell Obama his staff is doing it wrong.

This is where things get interesting: If the 10 percent increase in the cost of giving caused the person to reduce his gift by 10 percent, to $9,000, his tax savings would be 28 percent of $9,000, or $2,520. The government’s revenue loss would be reduced by $980 (from $3,500 to $2,520). The person’s gift to the university would be reduced by $1,000, almost the same amount. Since this high-income person would pay $980 more in taxes but give away $1,000 less, he would end up with an extra $20 for personal consumption.

Via Greg Mankiw.

FILED UNDER: Economics and Business, Government, , , ,
Steve Verdon
About Steve Verdon
Steve has a B.A. in Economics from the University of California, Los Angeles and attended graduate school at The George Washington University, leaving school shortly before staring work on his dissertation when his first child was born. He works in the energy industry and prior to that worked at the Bureau of Labor Statistics in the Division of Price Index and Number Research. He joined the staff at OTB in November 2004.

Comments

  1. chris in chicago says:

    Actually, Steve, that probably isn’t correct. I’ve worked in the nonprofit arena for years, and its a well-known fact that donors, including wealthy donors, rarely make gifts in order to receive tax benefits. It plays a part, but generally a small part, in their decision-making. Will they cut back if their contribution means an increased tax burden? Perhaps, but certainly not “by as much as the increase in their tax bills.” No one I know in the industry is very concerned about this; otherwise you’d be hearing an uproar from the nonprofit community.

  2. That’s strange, seems I’ve already been hearing that charitable donations are drying up all over the place already, especially in the — gasp! — fine arts.

    Funny what less disposable income will do to rationale people.

  3. Phil Smith says:

    I do a lot of business with non-profits, and their contributions began drying up months ago, even without a shift in the tax code. How much more impact it will have is hard to say.

  4. DL says:

    Face it folks. The idea that there will be less charitable giving by the private sector is exactly the reason that Obama is doing it. Anyone who doesn’t trust a big government type knows that they merely seek to expand government by creating more and more dependency. Cutting out charitable giving incentives will do exactly that.

    I suspect that his attack on Catholic hospitals is motivated by the same agenda – government will have to pick up the slack with DC control over health care – abortion on demand may even someday slip into abortion upon the government’s demand as is China -but slaughterers of babies could care.

  5. I do a lot of business with non-profits, and their contributions began drying up months ago, even without a shift in the tax code.

    Let’s see, what happened months ago? Oh that’s right, we elected a tax-and-spend-and-borrow-and-spend-and-tax-and-spend-and-borrow-and-spend kind of guy as President along with strong majorities for his party in the House and Senate.

    Like I said, rational people making rational decisions. And whatever you do, don’t mention school vouchers!

  6. Tlaloc says:

    Let’s see, what happened months ago? Oh that’s right, we elected a tax-and-spend-and-borrow-and-spend-and-tax-and-spend-and-borrow-and-spend kind of guy as President along with strong majorities for his party in the House and Senate.

    More pertinently a few months ago the spit and twine contraption that our economy became under Bush finally came apart. That happened in September, before the ’08 elections, Charles.

    I agree that this program is designed to move the activities of charitable organizations into the government, but since that seems to me exactly where they should have been all along I have no problem with that.

    Charity has always been about making the giver feel good, not addressing the issue, because individual charity is an enormously ineffective way to deal with problems (it is the very definition of throwing money at a problem with no plan). That being the case I see no reason that people should get a tax break for what is mental masturbation.

  7. Tlaloc says:

    abortion on demand may even someday slip into abortion upon the government’s demand as is China

    It’d be terrible if it came to that but notice that China didn’t get to their one baby policy just on a whim. They did it because their population was exploding and was threatening their country with mass starvation and worse. In other words it isn’t really the fault of the government that people bred indiscriminatly until such a policy became the least evil option (and it is the least evil option, as sad as that is).

    The question then is whether we’ll be short sighted enough to follow the same path. The work of some high profile conservatives to eliminate contraceptives and sex ed really helps push us towards the kind of future you dread.

    So which option is worse; a condom on a banana or forced sterilization/abortion? How wiling are you to cut off your own nose to spite your face?

  8. Steve Verdon says:

    Actually, Steve, that probably isn’t correct. I’ve worked in the nonprofit arena for years, and its a well-known fact that donors, including wealthy donors, rarely make gifts in order to receive tax benefits.

    Well what about the size of the gift? Empirical research is against you. It isn’t that no gift is made, but that smaller gifts are made. Read the article.

    I do a lot of business with non-profits, and their contributions began drying up months ago, even without a shift in the tax code. How much more impact it will have is hard to say.

    The change would be implemented in 2010, IIRC, thus it could delay a “rebound” in charitable contributions or reduce the size of the rebound.

  9. odograph says:

    It seems an odd move. I see no reason to put a disincentive on giving. On the other hand, there are options the rich have that the middle class do not:

    Want to beat estate tax? Does your son or daughter love to sail and scuba? Set up an oceanographic research institute, and have have your child donate his time (expenses reimbursed of course).

    Can we beat such things? Are there limits on donations to which you or your kin are principals?

    That might be where I’d look.

  10. PD Shaw says:

    If the tax deduction doesn’t encourage charitable giving, we should certainly get rid of it.

    But to get rid of it only for the people with high marginal tax rates (that is, the deduction is more valuable) makes no sense whatsoever.

    For my part, I will comment that I received only requests for charitable giving in the mail at home today. All prominently identified that the donations were tax deductible. They either think that encourages giving, or they fear we’re all idiots like Tom Daschle.

  11. Dave Schuler says:

    Recent research supports the finding that people give less as the cost of a charitable contribution rises.

  12. Pete Burgess says:

    The more money a person has in his/her pocket, the more willing he/she is willing to part with some of it. Do away with federal income taxes, establish a national consumption tax, and people will have more money in their pockets.

  13. Tlaloc, that’s just pure bullshit. Charity existed long before the first wet dream of a welfare state ever came into being. Nice of you to impugn the motives of everyone who does make charitable contributions though, even if your utopian altruism that can only be provided by the government comes with a double plus good helping of irony.

    Good charities do have plans and many of them do a fantastic job of serving those they choose to help. Many charities take things other than cash and most welcome any commitment of time. And what’s wrong with anyone feeling good for helping someone else? Must all help be impersonally provided by a faceless bureaucracy to be truly valid and worthy? Can we only feel good about helping people if the funds are funneled through the state?

    You are apparently just saying anything to get a response, but there’s no point in trying to reason with anyone who still wants to blame Bush for everything that happens. And I won’t touch your comment about masturbation with the proverbial ten foot pole.

  14. HankP says:

    Charles, why is it that government bureaucrats are faceless while people who work for charities aren’t? I’ve worked with non-profits, do you think the people who raise funds and manage the administration of the charities are known personally by the people the charity helps?

    Besides, this discussion rather misses the point – charitable contributions are by their very nature not amenable to rational analysis. I suppose changes in the tax laws might make some changes at the margins, but those changes will be swamped by the changes in the overall economy.

  15. Davebo says:

    I’m amazed, amazed! I tell ya that charitable contributions might decline at a time when people are desperate to make their next mortgage payment.

    And of course, I blame Obama. What else could I possibly do?

  16. Michael says:

    Funny what less disposable income will do to rationale people.

    Rich people don’t donate post-tax income to tax deductible charities. They donate long-term investments so that they don’t have to pay capital gains on the interest from the sale. It seems, to me anyway, more likely that the reduction in value of those investments that has slowed giving, not reductions in disposable income.

    abortion on demand may even someday slip into abortion upon the government’s demand as is China -but slaughterers of babies could care.

    I’m pretty sure the pro-choice movement will fight that.

    Do away with federal income taxes, establish a national consumption tax, and people will have more money in their pockets.

    Wow, magical consumption tax ponies! If you don’t reduce the amount of tax revenue taken in my the government, people (as a whole) will not have more money in their pockets, no matter what you tax. You’re just redistributing wealth.

  17. HankP – glad to hear your experience with government bureaucracies has worked out so much better than everyone elses. My experience is that people volunteering for charities actually care a great deal about what they do. Civil servants masters, somewhat less. Please note that the latter should not be taken as a slam on all civil servants any more than the former should be constued as unqualified praise of all volunteers.

    Davebo – What should you do? I don’t know? Maybe get a clue? The majority of mortgage problems are limited to a very small number of counties throughout the entire US. Do you think that charitable contributions only come from the residents of these same counties?

    Michael – I know it may come as a shock, but you don’t have to be rich to make charitable contributions. What you described of course happens for some rich folks, but I’m guessing an awful lot of charities would go under with the $50 and $100 contributions form Joe and Betty six pack. On a percentage basis, my charitable contributions greatly exceed the Obamas, the Gores, etc., as I suspect an awful lot of middle class folks’ contributions do. But I digress.

  18. Michael says:

    I know it may come as a shock, but you don’t have to be rich to make charitable contributions.

    Why would that come as a shock to me? I give to charity, heck I run a charity, and I’m no where near rich.

    What you described of course happens for some rich folks, but I’m guessing an awful lot of charities would go under with[out] the $50 and $100 contributions form Joe and Betty six pack.

    I’m sure they would, I know that mine wouldn’t be able to operate without small individual contributions. But people give to charities like that because of a strong connection to what they’re doing, and those people would be the most inclined to continue giving even if taxes change. People looking at the tax benefits of donations don’t bother seeking out Joe and Betty six pack, they give to one of the widely known mega-charities, which don’t really need those $50 and $100 donations.

  19. HankP says:

    charles, now that you mention it when I think of all the interactions I’ve had with various bureaucracies I would have to say that I’ve been more satisfied with the interactions I’ve had with government bureaucrats that with private sector bureaucrats. My interactions with government were far easier and more quickly resolved than with health insurance companies, for example.

  20. Michael says:

    My interactions with government were far easier and more quickly resolved than with health insurance companies, for example.

    Health insurance companies aren’t really a good example because, like utilities, you don’t usually have a choice in which you use. Yes, lots of people have private coverage, but the majority are covered by their employer’s plan, which the ultimate consumer doesn’t choose.

  21. Michael says:

    In fact, I’d bet if you were to name the top 5 worst companies you’ve dealt with, at least 4 of them make it difficult or impossible for you to switch to a competitor.

  22. HankP says:

    Michael, I can tell you that the worst companies I have to deal with on a regular basis are the phone companies Verizon and Qwest (I support small business computer systems). There are other options, and I recommend that my clients use them, but the competition doesn’t see to have helped the service levels at the telecoms.