Debating their tax-reform plan first proposed in 1981, Hoover Institution’s Robert E. Hall and Alvin Rabushka write, “it is perverse to tax the typical American to subsidize these elite institutions,” referring to nonprofits favored by the wealthy. “But granting tax deductions for gifts is precisely such a subsidy.”
Defenders of what they would call “donor freedom” against populist efforts to condition or curtail the tax benefits accorded nonprofit organizations often invoke the Tocquevillian tradition of American civil society. But Tocqueville was describing habits of association, religion, local self-government, and voluntary cooperation decades before there was a federal income tax, charitable exemption, or deduction. Civil society neither originates in nor depends upon the Internal Revenue Code. Indeed, as a term in and of itself, the “nonprofit sector” is a creature of the tax code; it’s not the same thing as civil society.
A further look at tax history itself, in fact, opens an interesting potential point of Tocquevillian agreement between populists skeptical of the special benefits enjoyed by establishment philanthropy and libertarians skeptical of using the tax code to alter or incentivize certain preferred private behavior in the first place. The federal corporate excise tax of 1909 exempted charitable organizations, and after the 16th Amendment permitting a federal income tax was ratified in 1913, the Revenue Act later that year included a charitable exemption in the first such tax. An attempt to include a charitable-contribution deduction, however, failed. “The deduction has always been popular, but it has never been unquestioned,” notes tax historian Joseph J. Thorndike in a 2013 paper for the Urban Institute and the Urban Institute-Brookings Institution Tax Policy Center.
Congress added one only four years later, in 1917, amid World War I and sharply higher tax rates. For four years, the United States thus had an income tax and charitable exemption, but no charitable deduction—a reminder that the deduction was a policy choice, as opposed to some sort of naturally required and/or constitutional right.
In more-recent history, some conservatives and libertarians who formulated and presented proposals for a flat tax have essentially made the same policy choice. Flat-tax proposals began to arise during the 1980s and gained currency in the ’90s—and with them, as Thorndike also notes, “talk of eliminating the charity deduction reappeared.” Flat-tax proposals generally seek to simplify the tax code, reduce its distortions, and strip away its preferences. How some have treated the charitable deduction—and why—offers an overlooked precedent for today’s intramural conservative debate over the privileged tax status of Big Philanthropy.
No lines on the “postcard”
Robert E. Hall and Alvin Rabushka of the Hoover Institution proposed a 19% flat tax on businesses and individuals in a 1981 Wall Street Journal op-ed. They fleshed it out in books published in 1983 and 1985, releasing a second edition of the latter in 1995. For individuals, the flat rate would apply to wages and pension benefits above an exemption of $25,500 for a family of four. No other income would be taxable and no other deductions allowed. There are no lines on the famous, and appealingly simple, flat-tax “postcard” they floated for home-mortgage interest or charitable contributions. For businesses, wages, pension contributions, materials costs, and capital investments would be deductible. In effect, it is a consumption tax—a wage tax on households combined with a cash-flow tax on businesses.
“Deducting contributions to worthy causes would be a thing of the past under our tax reform,” Hall and Rabushka write in 1995’s second edition of The Flat Tax, which Hoover is re-releasing in paperback later this year. They continue,
Will the nation stop supporting its churches, hospitals, museums, and opera companies when the tax deduction disappears? We think not. But we should also be clear that incentives matter—the current tax system with high marginal rates and tax deductions provide inappropriately high incentives for more contributions. The immediate effect of tax reform may be a small decline in giving. Later, as the economy surges forward under the impetus of improved incentives for economic activity, giving will recover and likely exceed its current levels.
According to Hall and Rabushka, “Churches have nothing to fear from” their proposal
and, like most people and institutions, would have much to gain from better economic conditions brought about by reform. Despite their dominant position in gifts, churches are not the leaders in fighting a tax reform that denies deductions. Instead, institutions serving the absolute economic and social elite—universities, symphonies, opera companies, ballets, and museums—are protesting the loudest. No compelling case has ever been made that these worthy undertakings should be financed by anyone other than their customers. A glance at the crowd in any of them will tell you that it is perverse to tax the typical American to subsidize these elite institutions. But granting tax deductions for gifts is precisely such a subsidy.
Permissible policy choice
After Hall’s and Rabushka’s proposal, on the issue of charitable deductibility, major conservative flat-tax proposals could be split into two categories:
- “pure,” Hall-Rabushka-style plans that eliminate the charitable deduction, along with almost everything else; and, …
- politically modified flat taxes that retain it, often alongside the mortgage-interest deduction.
Historically, policymakers and politicians joining Hall and Rabushka—who are Hoover senior fellows emeriti—in their choice have been Dick Armey and Richard Shelby, along with Steve Forbes. “Stay flat or die,” Armey said in 1995, when specifically contrasted with Arlen Specter’s retention of the charity and mortgage-interest deductions. In 1995, Forbes said,
Americans don’t need to be bribed by the tax code to give money. We were known as a generous nation, as one with an extraordinary array of charitable activities, long before we had the federal income tax. When people have more, they give more. When the flat tax is fully implemented, fund raisers will pitch the worth of the charity [rather than] this is a great way to save on taxes. We will see the revival of civic virtue.
Those modifying Hall-Rabushka to save the deduction have included Bob Dole and Jack Kemp, Phil Gramm, Ted Cruz, and Rand Paul, along with Specter. Of the charitable and mortgage-interest deductions, Specter said in 1995, “those two deductions are so deeply ingrained into the pattern of Americans that it is not practical to pass a flat tax, a tax that is flat without those two deductions.”
Policymaking questions, properly asked
Hall, Rabushka, Armey, and Forbes are hardly hostile to private charity or civil society. They just do not regard a federal tax deduction for charitable contributions as necessary to either. Conservatives on the other side of the question have disagreed as a matter of tax and social policy—not because deductibility is somehow an inviolable feature of the relationship between government and civil society.
Congress created the charitable deduction, has altered it repeatedly, and policymakers with serious limited-government credentials have questioned it. Whether it should be eliminated, retained, curtailed, or conditioned on a constitutionally permissible purpose are policy questions, properly asked, about incentives, distribution, and pluralism.
