Taxes

Obama Enlists Reagan to Defend His Limits on Tax Deductions

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As Matt Welch noted earlier today, at last night's press conference President Obama defended his plan to tax charitable contributions with a reference to Ronald Reagan:

What we've said is: Let's go back to the rate that existed under Ronald Reagan. People are still going to be able to make charitable contributions. It just means, if you give $100 and you're in this tax bracket, at a certain point, instead of being able to write off 36 percent or 39 percent, you're writing off 28 percent.

Peter Orszag, Obama's budget director, also name-checks the Gipper in his defense of the plan to limit deductions:

We are not eliminating the deduction—just reducing it to 28 percent (or $280 on the hypothetical $1,000 contribution) for the 5 percent of families at the very top of the income distribution. That is the same tax benefit that they would have enjoyed at the end of the Reagan Administration. 

A casual listener or reader might gather that Reagan supported the idea of making charitable contributions less than fully deductible for upper-income taxpayers, or at least that such was the policy by the end of his administration. In fact, however, top earners deducted reduced their taxes by 28 percent of their donations in 1988 because they were subject to a 28 percent income tax rate. Today, since the top rate is 35 percent, they deduct reduce their taxes by 35 percent of their donations. Obama wants to raise the top rate to 39 percent (by letting the Bush tax cuts lapse) while reducing deductibility the tax savings to 28 percent of charitable contributions, meaning that the contributions would be taxed at a rate of 11 percent for people in the top bracket.

Instead of simply saying this change is a handy way of raising money from people who can afford it, Obama administration argues that it eliminates an unfair advantage for the wealthy:

What it would do is it would equalize—when I give $100, I'd get the same amount of deduction as when…a bus driver who's making $50,000 a year, or $40,000 a year, gives that same $100. Right now, he gets 28 percent; he gets to write off 28 percent. I get to write off 39 percent. I don't think that's fair.  

This year, actually, Obama would get to deduct reduce his taxes by 35 percent of his contribution. But his point stands: Why should rich guys get a bigger deduction tax reduction for the same contribution? Maybe because they pay more in taxes to begin with. As I've said before, this is a natural result of combining deductions with progressive income tax rates (neither of which is necessarily a good idea).

Obama's other pretense here is that taxing charitable donations won't reduce them. "If it's really a charitable contribution," he says, "I'm assuming that that shouldn't be the determining factor as to whether you're giving that $100 to the homeless shelter down the street." But the whole idea of making charity deductible is to encourage more of it. It stands to reason, then, that making it less deductible will discourage it at least a little. At the margin, making philanthropy more expensive is bound to result in less philanthropy. Reasonable people can disagree about the size of this effect and about whether Obama has better plans for the money he is in effect diverting from charitable organizations. But denying that any such diversion is occurring sounds a lot like, you know, the way politicians usually behave. What is the phrase I'm looking for?

Clarification: As a couple of commenters pointed out, Obama wants to reduce the deductibility of charitable contributions for people in the top bracket from 100 percent (meaning that if your income tax rate is 39 percent, a $10,000 donation reduces your taxes by $3,900) to 72 percent (meaning your tax rate is still 39 percent, but a $10,000 donation reduces your taxes by only $2,800). For someone in the 36 percent bracket, deductibility would be reduced from 100 percent to 78 percent (cutting the tax reduction for a $10,000 donation from $3,600 to $2,800). I've adjusted my language above a bit to clarify the distinction between the deduction (the reduction in taxable income) and the resulting tax savings. Another way to look at it (as I suggest above) is that Obama wants to start taxing heretofore tax-free charitable donations (along with other expenditures that currently are 100 percent deductible) at a rate of 8 percent or 11 percent, depending on the bracket.