By Edward Zelinsky
One widely-discussed possibility for reforming the federal income tax is limiting the deduction for charitable contributions. Whether or not Congress amends the Code to restrict the income tax deduction for charitable contributions, Congress should limit the charitable contribution deduction under the federal estate and gift taxes. Such a limit would balance the need for federal revenues with the desirability of encouraging charitable giving.
On December 11th, the advocacy group Responsible Wealth called for the federal government to tax estates over $4,000,000 at rates starting at 45%. Among those joining this call were heirs to old fortunes such as Abigail Disney and Richard Rockefeller and owners of new wealth such as Bill Gates, Sr. Most notably, Warren Buffett agreed (as he has in the past) with this recent plea for higher estate taxes.
I am a fan of my fellow Nebraskan and agree with him that the federal government should impose estate taxes, particularly on large fortunes. I also admire Mr. Buffett for the Giving Pledge which he has promoted with the younger Mr. Gates. Under that Pledge, wealthy individuals commit to giving at least half of their wealth to philanthropy.
There is, however, considerable tension between the Buffett commitment to federal estate taxation and the Buffett commitment to philanthropy. By virtue of the estate tax charitable deduction, when a wealthy decedent leaves part or all of his estate to charity, no estate tax is paid on these contributed amounts.
It is perfectly plausible to call for estate taxation only for those who don’t distribute their wealth to philanthropy. It is, however, hard to reconcile that position with Responsible Wealth’s advocacy of strong estate taxation. Mr. Gates, Sr., for example, declared that “it would be shameful to leave potential revenue on the table from those most able to pay.” However, that is precisely what happens when large estates go to charity, namely, estate tax revenue which would otherwise flow to the federal government is instead diverted to charity. Such charity may be worthwhile but it does nothing to reduce the federal deficit.
Similarly, Ms. Disney argued that “a weak estate tax” falls “on the backs of the middle class,” presumably because the federal government will respond to reduced estate tax revenues by deficit financing, by raising other taxes on the middle class or by reducing government spending. However, when an estate is distributed to charity free of estate taxation, the government confronts these same choices.
A compromise could preserve the incentive for charitable giving while also generating some estate tax revenues for the federal government: Limit the estate (and gift) tax charitable deduction.
Many, including President Obama, have suggested such limitations on the income tax charitable deduction. If, for example, an individual is in the 35% federal income tax bracket, the President has proposed that the donor receive a deduction as if he or she were in the 28% bracket. In a similar fashion, the estate tax charitable deduction could be curbed, thereby generating some additional revenues for the federal fisc while also keeping a tax-incentive for charitable giving.
Consider, for example, a billionaire who leaves his entire estate of $1,000,000,000 to charity. To simplify the math, let’s assume that this billionaire would pay estate tax at the 40% rate if he did not bequeath all his assets to philanthropy. Because this $1,000,000,000 bequest is fully deductible for federal estate tax purposes, no tax is paid in this example. If this billionaire had not made this charitable bequest but had instead left his money to his children, the federal government would have received estate tax revenues of $400,000,000.
Suppose now that Congress limits the federal estate tax deduction to 70% of the amount donated to charity. In this case, the billionaire would leave a taxable estate of $300,000,000. At a 40% rate, this would require a federal estate tax payment of $120,000,000.
To provide the cash to pay this tax, this billionaire would probably reduce his charitable bequest to retain cash to pay this estate tax. However, at the end of the day, charity would receive the bulk of this billionaire’s assets while the federal government would receive some estate tax.
A limit on the estate tax charitable deduction could be constructed to fall only on relatively larger estates. For example, the first $10 million of charitable bequests could be fully deductible for estate tax purposes and only the amount gifted over that threshold would be deductible in part.
Alternatively, the limit could be phased in as charitable contributions increase. For example, the first $10 million of charitable bequests could be fully deductible for estate tax purposes. Then the next $50 million of philanthropic gifts could be 90% deductible and any further gifts would be 70% deductible for federal estate tax purposes.
The details are less important than the basic policy: By limiting the estate tax charitable deduction, all large estates donated to philanthropy would pay some federal estate tax revenues at a reduced rate. This would balance the need for federal revenues with the encouragement of the kind of charitable bequests quite commendably encouraged by Mr. Buffett and the Giving Pledge.
Edward A. Zelinsky is the Morris and Annie Trachman Professor of Law at the Benjamin N. Cardozo School of Law of Yeshiva University. He is the author of The Origins of the Ownership Society: How The Defined Contribution Paradigm Changed America. His monthly column appears here.
Subscribe to the OUPblog via email or RSS.
Subscribe to only business and economics articles on OUPblog via email or RSS.
Image credit: Macro shot of the seal of the United States on the US one dollar bill. Photo by briancweed, iStockphoto.
The post Limit the estate tax charitable deduction appeared first on OUPblog.
Edward A. Zelinsky is the Morris and Annie Trachman Professor of Law at the Benjamin N. Cardozo School of Law of Yeshiva University. He is the author of The Origins of the Ownership Society: How The Defined Contribution Paradigm Changed America. In this article, he criticizes proposals for the states to administer private sector retirement savings plans. Read his past OUPblog posts here.
Legislators throughout the country are proposing that states start to administer private sector retirement savings plans. While the details of these proposals vary from state to state, they all provide that the states should embark upon the business of managing private sector individual account arrangements.
In Connecticut, for example, the state senate, before recently adjourning, passed S.B. 652 which would have created a state-sponsored “universal 401(k).” This legislation would have mandated the state’s comptroller to establish and administer a state-run “tax-qualified defined contribution retirement program” for the self-employed, the tax-exempt institutions, and the “small employers” of the Nutmeg State.
On 
the other side of the country, currently pending in the California legislature is AB 2940. If enacted, this legislation would authorize CalPERS, the Golden State’s public pension plan, to accept from California residents payroll deposits for state-administered individual retirement accounts. Similar legislation has been introduced in a variety of other states.
The concern animating all these proposals is well-founded. The defined contribution paradigm has worked well for many American households, in particular, middle- and upper-middle families who save and invest through 401(k) plans and IRAs as well as the employees of large employers which sponsor and typically match such employees’ 401(k) contributions. Despite this success, it is troubling that lower-income workers and smaller employers are severely underrepresented in the individual account system.
This problem, however, has deeper roots than is acknowledged by the advocates of state-administered private sector retirement plans. The current retirement savings system relies heavily on the income tax benefits of contributing to tax-qualified arrangements such as 401(k) accounts and IRAs. Those tax benefits are substantial for middle class and more affluent workers who defer significant federal income taxation through their tax deductible contributions to such accounts.
However, low income workers today do not pay significant federal income taxes. They thus have little, if any, tax motivation to make 401(k) or IRA contributions. A deductible contribution is not a meaningful incentive for someone in a low or zero tax bracket. This would remain the case even if states compete with the private sector suppliers of retirement plans. A low-income worker who derives no tax benefit from a deductible IRA contribution at his neighborhood bank will similarly derive no tax benefit from contributing to an IRA administered by his state’s comptroller.
Moreover, even if they want to make such retirement savings contributions, most low-income workers lack the discretionary income to do so.
The private market for retirement savings products is broad and deep. Today, every reader of a major newspaper or of the internet is bombarded by the advertising of the financial services industry, selling 401(k) plans and IRAs. There is no market failure requiring state-provided retirement savings for the private sector.
There is, furthermore, an unintended irony in the idea that the states should ride to the rescue of the private retirement system. The states can’t keep in order in their own pension systems. The states’ underfunding of their own pension plans is today a serious problem. There is something untoward about states which cannot solve their own pension difficulties purporting to act as the saviors of the private sector retirement system.
There is an important step the states can take if they are serious about encouraging 401(k) and IRA participation among low-income individuals. In particular, the states could, in their own income taxes, match part or all of the federal savers’ tax credit which subsidizes the retirement saving of low-income persons by providing a tax credit if a low-income worker contributes to an IRA or 401(k) account.
However, there is no compelling case for the states to enter the private retirement savings business. Let them put their own pensions on solid financial footings first.
ShareThis
Saturday is World Aids Day. We asked authors Gerald M. Oppenheimer and Ronald Bayer to help us commemorate this important holiday, to help us remember why AIDS research, awareness and education is so very important to our society. Oppenheimer and Bayer are the authors of Shattered Dreams: An Oral History of the South African AIDS Epidemic which uses interviews to tell the story of how physicians and nurses in South Africa struggled to ride the tiger of the world’s most catastrophic AIDS epidemic. In the original article below they reflect on the progress made and work still to be accomplished.
Once again it is almost World AIDS Day and in cities and communities around the world, there will be commemorations marking the date, December 1. But this year may be different. Some will begin to say, as they did in the United States, “Enough!” Too much energy, too many resources, have been devoted to an epidemic whose dimensions may have been exaggerated. They will point to a recent report from the United Nations suggesting that the global burden of HIV have been overestimated. Instead of the approximately 39 million people, as the world body previously reported, it is now thought that the numbers are closer to 33 million individuals. The number of newly infected, said the report, is declining where it is not leveling off. Seizing on these numbers, we will be urged to breathe a collective sigh of relief. (more…)
Share This
