Editors’ Note: Shirley Tillotson offers some historical perspective on recent proposals that would allow taxpayers to make charitable donations to state and local governmental agencies as a way of dealing with new provisions in the recently passed Tax Cuts and Jobs Act that limit state and local tax (SALT) deductions.
The border between tax and charity is patrolled by heavily armed gangs of tax lawyers. Great place to go if you’re fixin’ for a fight. And yet, some American states are brashly planning to take a stroll on this legal wild side. The fight is about contemporary law, but behind it there is a history of cultural connections between charitable fundraising and welfare state taxation. Charity is supposed to be voluntary and given with emotion, tax payments are assumed to be coerced and offered only grudgingly. But both contemporary politics and the history of philanthropy testify that the border between the two isn’t always stable. Hence the patrols.
The current border scuffle was sparked by the GOP’s December tax changes.
In New York, New Jersey, and California, taxpayers (mostly upper middle income and richer) are facing increased federal income tax bills. Next year, they will only be able to deduct $10,000 of their state and local taxes (SALT) when stating their federally taxable income. The SALT deduction has been capped. If they currently pay, say, about $13,000 in combined tax on an income of $140,000 and property tax on a suburban home, then in this terrifying new world, their taxable income will be about $3,000 higher than it was last year, all things being equal.
Back of the envelope calculation: that increase in federally taxable income for an unmarried homeowner in Sacramento, CA would mean about $63 more a month in federal tax. Not nothing. Apparently enough to inspire voters with such upper middle class tax bills to pressure local and state governments to reduce their property and state income taxes to balance their increased federal tax obligations.
The conservative designers of the SALT cap would no doubt be happy to see the kind of hard cuts to public spending that would follow from lower SALT revenue. But blue state governments aren’t accepting that development without a fight. Instead of cutting the SALT, California and New Jersey officials are talking about replacing tax payments with (nudge nudge wink wink) “charitable donations” to these lower levels of government. Charitable donations are deductible (with a much higher limit) from federally taxable income. It’s proposed that taxpayers would donate the amount of their state and local taxes instead to a state foundation that is authorized to spend on public goods. Voilà, no federal tax increase and no hit to public spending.
Not so fast. The most sober of tax law sites describes this plan as an attempt to “game the system.” Law professor Andy Grewal notes that, absent a – very unlikely – advance authorization from the IRS, these schemes “face substantial uncertainty.” That phrase is pretty much tax lawyer talk for “you’d have to be out of your mind to try that on.”
Tax lawyers on both the tax collector and the taxpayer side know that changing the name of a chunk of income has been a much-used tax dodge. There are well-honed tools to use against that trick, legal tests of “substance” – you can’t make income not income by calling it something else, or make a purchase a gift by calling the buyer a donor. Charitable deductions have long been manipulated in ways that attract the dodge-sniffing dogs of the IRS.
Those dodges have been made possible partly because charitable deductions are not simply a lovely gesture on the part of government to encourage our generosity. Tax and charity share a history of intertwined incentives. By reducing donors’ taxes, governments have tried both to assuage complaints about the tax burden and to encourage individuals’ support of social goods. The reductions that tax policy allows for charitable giving, like deductions or tax credits for retirement saving or borrowing costs, recognize that there is a social benefit, not just a private, individual one, entailed in such uses of personal income.
The SALT deduction is a different sort of thing. It’s not about encouraging or discouraging social spending. It’s a distinctive feature of American federalism, an artifact of states’ rights. Oddly, from this Canadian’s perspective, it gives the junior levels of government the power to cut federal revenue unpredictably, simply by raising the amount that their taxpayers can deduct from federal taxable income. Any Canadian who knows about our struggles in the 1950s to avoid this problem might well wonder how or whether the federal/state diplomacy around those interdependent tax systems can have peacefully functioned.
In any case, it’s easy to understand why the GOP tax plan is a shock to the U.S. fiscal system and not just to individual taxpayers.
It’s the combined impact of pocketbook politics and the politics of fiscal federalism that has sparked a polite and professional gang rumble among tax lawyers over the “gifts for taxes” scheme. On one side, those opposed hold that a deductible charitable gift is, by law, only that for which the giver gets nothing back (except a warm feeling). If there’s a quid pro quo, it’s not a gift. In the proposed scheme, the gift would not be something given for nothing. It doesn’t matter whether the exchange is complicated and indirect: what’s being proposed here is not, in its substance, a gift.
On the other side, those supporting the scheme argue that there is definitional daylight visible between a lowered tax liability and the kinds of quid pro quo (such as money or property) that make a gift effectively a purchase. They point out that donations to state agencies, such as public museums, are now allowed as charitable deductions against federal taxes, a benefit to donors that is well-established in law and practice. Why, then, should not that benefit be permissible in return for donations to the state department of transportation (or a proxy foundation set up to fund the whole array of state and local public services)?
As with many tax changes, the opposition to this one is based on reasonable worries about a rocky transition process. Even if you think, as I and some others do, that the SALT cap could have a progressive impact on income taxation and usefully make for a more stable federal tax revenue, you might sensibly be alarmed by the process.
But there is a cultural, not just a legal, confusion of donation and taxpaying. In my 2008 book, Contributing Citizens, I describe the beginnings in the 1930s, 1940s, and 1950s of fundraising practices in Canada and the United States that, even to observers at the time, made charitable giving look strangely like the paying of taxes.
By the late 1950s, the United Way method was being challenged for taking the personal connection, the philanthropic emotion, out of giving. Big city fundraising federations aggregated a host of diverse agencies within one appeal. The pitch became increasingly abstract: donors were no longer asked to think about the specifics of poor widows, displaced ex-convicts, or (the classic) “crippled” children, but about need in flatly general terms. Giving was more frequently done by payroll deduction, one’s gift appearing as a pay stub entry next to the income tax deduction, rather than coins being scrimped out of the housekeeping budget, handed to a canvasser across the doorstep.
Making an appeal to a deeply felt altruism had become increasingly suspect. Older kinds of charitable motivation were disparaged as sentimental disrespect of the agencies’ clients. Fundraisers who were reluctant to tug on the old Dickensian heartstrings tried to bring donors together in the name of other returns, large and small, in exchange for giving. Good publicity for your company or your organization worked. A special football game for the Red Feather appeal brought out crowds to chip in. These and many smaller benefits became, and remain, a part of fundraising in which giving is also partially purchase.
In the abstract pitches, a universalistic note echoed the benefit logic of the welfare state income tax: “Everybody Gives, Everybody Benefits.” Fundraisers broadened their donor base by arguing that one day you might need an agency’s services, so give now to ensure you’ll have that benefit later on. Finally, the methods of federated fundraising, even from their beginning, shared with the IRS a key objective: trying to reduce the number of free-riders. You benefit from these services, so you should contribute.
Paying taxes and making charitable gifts are indeed related: both fund aspects of our collective life. Their similarities are less often contemplated than their differences. The charitable deduction connects them, but also puts them in competition, emphasising the contrast which, until this latest turn in tax politics, was largely taken for granted. As the lawyers battle, we onlookers may deepen our understanding of how charitable giving and taxes are related. I doubt, however, that we will see that relationship change so fundamentally as to turn U.S. state and local governments into charities whose collection methods will have to include the police and the tax courts.
Shirley Tillotson is an Inglis Professor at the University of King’s College, Halifax, and a retired member of the Dalhousie University Department of History. She is the author of Contributing Citizens: Modern Charitable Fundraising and the Making of the Welfare State, 1920-1966 and Give and Take: The Citizen-Taxpayer and the Rise of Canadian Democracy.