After the Budget Axe Falls
Can the arts, education, job training, science, and aid for the poor survive government cutbacks? Tax credits for charity could be the key.
Nothing would seem more vital to the success of "Reaganomics" than the successful privatization of federal programs being cut back under the Reagan budget. To this end, the president has called on the spirit of private-sector voluntarism to meet community needs. At issue are aid for the poor, the arts, education, basic research, the environment, and countless community programs that might well be supported through private channels.
Unfortunately, however, even as the Reagan program takes effect, private nonprofit organizations are tightening their belts. This is partly because many are themselves recipients of federal aid and stand to lose an estimated $27 billion from budget cuts over the next four years. In addition, the reductions in tax rates inadvertently but powerfully discourage private giving by reducing the leverage of the tax deduction for charitable contributions.
For those in the highest bracket, the tax cut effectively raises the net "cost" of a $10,000 donation by two-thirds, from $3,000 to $5,000. This effect is partially offset by a new tax provision extending the charitable deduction to lower-bracket taxpayers who would not normally qualify for itemized deductions. On balance, however, the high-bracket contributions constitute the majority of charitable donations. So despite the considerable amount of money being returned to private hands by the cut, economists are divided over whether it will generate an increase in the amount of private giving—let alone meet the enormous demands of privatization of charitable efforts.
But why should the public consent to this dismal arithmetic? After all, there's no reason taxpayers could not compensate for any conceivable ill effects of the Reagan budget simply by contributing more of their tax savings to private charity. Unfortunately, however, the incentives to do so are weak.
On average, Americans contribute 2.5 percent of their personal income to philanthropy—less than one-tenth what they pay in taxes. In fact, polls have shown that Americans often say they are willing to be taxed more than they contribute voluntarily to causes like the arts, the environment, aid for the jobless, etc. The reason for this is not necessarily laziness. Unlike taxes, contributions are voluntary and are not leveraged by the contributions of 100 million other taxpayers. Voluntarism is by nature hard-pressed to compete with the government monopoly on taxation.
There is a simple tax reform that could change this situation: expand the present charitable tax deduction into a dollar-for-dollar credit, so that taxpayers could write off the full expense of their charitable contributions, up to some portion of taxes. In effect, taxpayers would be able to allocate some portion of their tax "bills" in any way they see fit—for the poor, the unemployed, the arts, education, science, the environment, or whatever—the sole restriction being that no one be a direct beneficiary of his own contribution.
The benefits of this reform could be far-reaching and dramatic. A 15-percent credit against personal income taxes could raise as much money as the present total of private philanthropy, or about $45 billion. Private organizations that provide aid for the down-and-out could expand the programs they find effective in their areas. The arts, culture, and scientific research could thrive with none of the drawbacks of federal control, avoiding the political controversies that have plagued federal agencies like the National Endowments, the National Science Foundation, and the Corporation for Public Broadcasting.
Government programs could also be eligible for credits. Taxpayers could then contribute more to, say, the space program, school lunches, job training, or even the departments of Energy and Education.
Under this scheme, government programs would have to compete for the taxpayer's dollar. Credits would in effect create a kind of market in which individual taxpayers choose those helping programs they find valuable, rather than having to settle for the decisions of politicians and bureaucrats. Taxpayers who are dismayed with the antipoverty strategies of the Department of Health and Human Services might contribute to more effective private alternatives.
Of course, Congress could still budget more money to HHS if it pleased. Taxpayer contributions, however, would provide a significant benchmark of public support that few politicians could afford to ignore. Furthermore, by promoting private-sector alternatives, credits would undercut the demand for ever-more government programs.
In creating a degree of competition within the public sector, tax credits would attack a root cause of government waste and inefficiency and promote more productive, responsive, and diverse public services. For the first time, the American genius that is sparked by competitive enterprise might be unleashed within the public sector: public programs would be matched against private social entrepreneurs with creative or innovative programs in vying for donations stimulated by the tax-credit rule. The opportunities are endless: private job-training and apprenticeship projects, neighborhood beautification and environmental cleanup, services for the elderly and indigent, preventive health-care assistance, consumer education, or whatever.
It is not unreasonable to suspect that in many cases private services would succeed where government has failed. For example, private consumer-information groups frequently provide more useful, timely, forthright consumer advice than regulatory bureaucracies like the Food and Drug Administration, the Federal Trade Commission, or the Consumer Product Safety Commission.
Indeed, with tax-credit funding, private consumer groups could more aggressively publicize their findings through counteradvertising. Not only would such information be more stimulating than anything emerging from the presses of the Government Printing Office; it would also have the immense advantage of leaving consumers free to make informed decisions about what is in their interests, rather than subjecting them to the dictates of government bureaucrats.
Economically, the basic principle behind credits is to replace government monopoly with consumer choice in the public sector. This marks a radical departure from mainstream economic theory, where it is generally assumed that government must provide certain "public goods" whose benefits are commonly shared. This assumption is taken for granted by all but the "purest" free-market economists. It can be traced back to Adam Smith, who assigned to the sovereign
the duty of erecting and maintaining certain public works and certain institutions, which it can never be for the interest of any individual, or small number of individuals, to erect and maintain; because the profit could never repay the expense to any individual, or small number of individuals, though it may frequently do much more than repay it to a great society.
What Smith failed to recognize is that there is no reason at all why the presumed duty of providing certain public goods must be a monopoly of the sovereign. Once the money has been collectively raised, the public individually can just as well allocate it to independent institutions.
Nevertheless, Smith's successors have almost always taken for granted a state monopoly over the provision of public goods. So their arguments have been about what it should provide. Liberal economists, taking a broad interpretation of Smith's "great society," have argued for the inclusion of a host of social programs in the public sector. On the other hand, conservatives have argued for a more restrictive role for government, limiting the public sector to such traditional areas as roads, police, and defense.
Coincidentally, the extraordinary expense of defense has often imparted a de facto military slant to conservatives' budgets, a point often exploited by liberal propagandists. Under credits, this would be less of an issue, since taxpayers could contribute to guns or butter, as they see fit. In this respect, credits offer a constructive alternative to the traditional prescription of domestic budget cuts. Politically, credits have the unique appeal of offering more and better public services precisely by means of reducing government control.
Legislators, of course, would have to settle various technical issues before a tax-credit system could be implemented. They would demand guidelines to prevent flagrant abuse of credits, such as the creation of bogus charities to evade taxes. Evasion is also possible under the current system of deductions, of course, and is one reason why the Internal Revenue Service oversees nonprofit organizations. Credits would, however, make cheating more lucrative and thus would probably involve increased IRS oversight of charitable organizations.
Further questions would inevitably arise over the conditions of credit eligibility. As under the current deduction system, a tax-credit system might also exclude membership dues in nonprofit organizations to the extent that the dues gain benefits for the members. In the case of religious organizations, legislators may decide to part from the present system and distinguish between contributions spent on works of charity and contributions spent on more comfortable pews or on other, sectarian ventures. This is an important consideration, since one-half of private philanthropy currently goes to religious organizations.
The additional question of what portion of the income tax to allocate to credits would also have to be decided. Given the current controversy over the mounting federal deficit, legislators would most likely oppose a measure that would mean less federal tax revenue. Credits, however, would alleviate many of the problems posed by the Reagan budget cuts. The implementation of a tax credit limited to 10 percent of one's income-tax liability, for example, would free up approximately $30 billion for private giving—enough to cover all of the fiscal 1982 cutbacks in funding for social programs, with a huge amount left over—an amount equivalent to the budgets of the National Endowments for the Arts and the Humanities, NASA's planetary exploration program, the Corporation for Public Broadcasting, and the US Olympic Committee to boot.
The tax-credit principle could be taken a long way. Eventually, perhaps, the ceiling on contributions could be abolished, so that taxpayers could determine for themselves just how much of their tax-designated income to allocate to government. In such a world, government spending would be largely determined by more direct taxpayer demand, though Congress would still control the overall tax bite, as well as the appropriation of excise taxes, tariffs, and, possibly the corporate income tax (which could, however, also be made credit-eligible).
By being able to contribute the full amount of their tax liability to programs of their choice, taxpayers could avoid paying for any programs they disapprove of. Moral Majoritarians, for example, would not have to contribute to the subsidization of secular humanism, nor pacifists pay for weapons. Even in foreign-policy matters, taxpayers could pick and choose just what foreign countries, if any, they wished to aid.
Even short of this, however, tax credits would provide enormous benefits. A modest ceiling of 10 or 15 percent of taxpayer liability could go far to reverse the trend of recent decades towards ever-greater dependence on government. Rather than look to politicians and bureaucrats to fund public services, taxpayers could take matters into their own hands. This might undermine the whole system of pork-barrel politics—a proposition that not all politicians will look upon favorably, of course.
Nevertheless, few reforms could offer a more attractive way out of the longstanding zero-sum game between proponents of government-provided services and advocates of limited government. By giving all taxpayers some direct choice in how their money is spent, there is no reason that both goals—the provision of human services and limited government—could not be achieved. Taken seriously, there is no telling how far such a reform might lead toward a society that respects individual freedom.
Dale Gieringer is a public- and social-policy consultant with the Decisions and Ethics Center of Stanford University's Department of Engineering-Economic Systems.