Editors’ Note: We’ve been on a brief hiatus while working on some history of philanthropy manuscripts, and at the same time, internalizing the U.S. presidential election results. On the latter topic, fellow HistPhil co-editor Benjamin Soskis published a piece for The Chronicle of Philanthropy earlier this month. Two weeks ago at ARNOVA, I presented some initial thoughts on philanthropy, American race relations, and a Trump era which I plan to elaborate in the epilogue to my forthcoming book on elite philanthropy and American race relations during the first half of the twentieth century. More immediately, we look forward to an upcoming HistPhil discussion on archives and transparency so please stay tuned! In the meantime, Ajay K. Mehrotra adds to our philanthropy & the state forum by discussing the role of U.S. tax policy in shaping American philanthropy. Thank you for this contribution, Ajay! (-Maribel Morey, co-editor of HistPhil).
Thanks to Maribel, Stan, and Ben for the kind invitation to blog briefly about the important role of the U.S. fiscal state in the history of American philanthropy. I’ve been an avid reader of this blog, and I’m honored to provide my thoughts on how the history of U.S. tax policy has shaped American philanthropy.
As I’m sure many readers know, there are at least two ways in which tax and fiscal policy affect philanthropy: (1) the tax-exempt status of charitable organizations; and (2) the individual tax deduction for charitable giving. Both of these tax rules and policies have interesting origins and histories. Although I didn’t get a chance to delve too deeply into this topic in my book, Making the Modern American Fiscal State, it is a subject that has interested me for some time, and one that I enjoy teaching as part of my introductory federal income tax courses in law school and in my American history classes.
While the tax-exempt status of charitable organization is an obvious benefit, it is generally the second tax benefit – the individual deduction for charitable giving – that is frequently considered more important mainly because this benefit provides donors with a financial incentive for giving. In so doing, the second benefit (the tax deduction) provides the resources that keep charitable organizations going, while the first (tax-exempt status) ensures that legitimate non-profits are not taxed on the gifts they receive.
In this post, let me begin by taking a brief look at the historical beginnings of the funding source: the charitable contribution deduction.
The charitable deduction was not part of the first permanent U.S. income tax of 1913, but it did not take long for Congress to see the wisdom of including a tax incentive for charitable giving. Like many other key tax provisions, the charitable deduction originated during wartime. More specifically, the War Revenue Act of 1917, enacted soon after U.S. entry into World War I, ushered in the tax benefit as part of a radical transformation of the tax system.
Because of the fiscal demands of waging a global war, income tax rates skyrocketed and exemption levels declined during the Great War. Whereas before the war the highest marginal rate on individual income did not exceed 7%, and only about 2% of the labor force was paying any income taxes, by the height of WWI all that changed: the top marginal rate reached up to 77% and nearly 20% of American families were paying income taxes. Still, the income tax was mainly limited to the country’s wealthiest individuals – the same group that frequently gave to charities and other non-profits.
As a result of this wartime “soak-the-rich” tax system, many lawmakers feared that wealthy individuals would no longer have the “surplus” income to give to educational and other non-profit organizations. With these unprecedented tax rates, many believed that giving to charities would simply dry up. Thus, the federal charitable contribution deduction was designed not only to provide wealthy Americans with tax relief, but also to channel private resources towards publicly-minded charities.
As one 1917 Washington Post editorial explained, “If the government takes all or nearly all of one’s disposable income or surplus income, it must undertake the responsibility for spending it, and it must then support all those works of charity and mercy and all the educational and religious works which in this country have heretofore been supported by private benevolence.”
By structuring the tax benefit as a deduction, the federal government was ensuring that Uncle Sam would be a partner in charitable giving. In this way, the public sector and the nation-state became integrally intertwined with private giving. Every tax-deductible charitable contribution since 1917 has included both the private donor’s giving and an accompanying subsidy from the U.S. Treasury via the tax deduction.
The tight link between private giving and public subsidy soon became a compelling rationale for the persistence of the charitable contribution deduction – one that continues to this day. Indeed, one of the primary justifications for granting organizations the legal privilege to receive tax-deductible donations (and to be a tax-exempt, 501(c)(3) organizations) hinges on the quasi-public functions of such organizations. Most tax policy experts, back then and today, would agree that one of the key reasons for the deduction, and hence the public subsidy, is that most charitable organizations provide public goods or quasi-public goods. At least in theory, organizations that benefit from the charitable donation deduction should be providing goods and services that are similar in nature to government spending. Think of the Red Cross and disaster relief. In short, we’ve permitted the deduction to exist because we believe the charitable sector ought to be complementing the public sector.
In later years, the deduction for individuals was also justified as a proper way to define net taxable income. Under the notion of a comprehensive income tax, first articulated by economists in the 1920s, the process of giving away money to charity benefited others, not the donor/taxpayer and hence the donor/taxpayer was entitled to deduct such giving from her overall tax base.
In sum, like many other presently existing tax preferences, the charitable contribution deduction had its origins during wartime. Although the high marginal rates that were introduced during WWI subsequently became reduced, the preference for charitable giving did not wither away. Indeed, it became even stronger and was expanded to include many different types of tax-exempt, non-profits. As historian Joe Thorndike has aptly put it, “if World War I made the world safe for democracy, it also made the tax laws safe for philanthropy.”
-Ajay K. Mehrotra
Ajay K. Mehrotra is the Executive Director and a Research Professor at the American Bar Foundation, an independent, Chicago-based, non-profit research institute that focuses on the empirical and interdisciplinary study of law, legal institutions, and legal processes. He is also a Professor of Law at the Northwestern University Pritzker School of Law. His scholarship and teaching focus on legal history and tax law. More generally, his research explores law and political economy in historical and comparative perspective, with a particular focus on tax law and policy. He is the author of Making the Modern American Fiscal State: Law, Politics and the Rise of Progressive Taxation, 1877-1929 (New York: Cambridge University Press, 2013). He is the co-editor (with Isaac William Martin and Monica Prasad) of The New Fiscal Sociology: Taxation in Comparative and Historical Perspective (New York: Cambridge University Press, 2009).