A Charity Premium and Premature Taxation, pt 1.

All things being equal, is it better to have tax revenue or untaxed charitable donations? From a taxation point of view, I think the fact that we don’t tax donations to non-profits indicates that we believe whatever percentage that would have gone to the Treasury is better spent by a non-profit, whether American Red Cross, Doctors Without Borders, or even individual private schools and universities.

The reputation of government spending does little to suggest otherwise. Politicians’ pet projects can be notoriously wasteful. Though perhaps Josh can better comment on this, Boston’s Big Dig cost $14.6 billion to push a 3.5 mi. highway underground. Cost effective? The infamous bridge to nowhere, the Gravina Island Bridge, was projected to cost nearly $400 million, all to connect a city less populous than this author’s New Jersey suburb to an island of 50 residents and an airport.

Government benefits and pension plans are so generous they have been bankrupting states during this recession. The fattest pension check in New York State weighs in at a whopping $261,037 annually, all while the holder simultaneously earns $280,000 in salary as SUNY Albany president. And of course, 20 cents of every dollar taxed these days goes into the Defense or Homeland Security Budget and deceptively, a borrowed nickel goes to the separate, unbudgeted, and outrageously expensive Iraq and Afghanistan wars. Always frustrating is government spending financing the government debt, which of course is expected to increase due to recession borrowing. And if we value current worldwide suffering more than potential suffering of indebted Americans, it’s better to spend money helping people now than later.

For many, government spending priorities just don’t reflect those of rational and progressive citizens. I’m not even talking about libertarians, though as Josh pointed out, the existence of a charity premium is a strong case for a smaller government. Spending $663 billion on Defense while Energy gets $26 billion, National Science Foundation gets $7 billion, and NIH gets $32 billion. For people interested in… say, science research and a cure for cancer… this is not an ideal allocation of resources. Donating to Columbia University, on the other hand, or Howard Hughes Medical Institute, or the Susan G. Komen Foundation, can seem like a smarter way of promoting more important societal goods.

It’s hard to imagine that particularly efficient charities like the Gates Foundation, or Partners in Health, or any of the others we’ve named so far, couldn’t spend their money better, and create more utility for people, than the U.S. government. This suggests that there’s a “charity premium” (if I may boldly coin a term) when your dollar is invested by a good non-profit instead of by the government. Put another way, if you could choose to either donate your money to the government, or donate it to charity, donate it to charity.

A few criticisms. Are charities more efficient than government agencies? Not all, but some, certainly. Charities are independently rated. On Charity Navigator, for example, any charity that spends less than 30% of its budget on program expenses automatically gets zero stars. Charities that spend too much of its budget on fundraising similarly are downgraded. Of course, it can be possible to fudge the numbers in order to game the ratings. For example, opening an office in New York is an administrative expense. Opening an office in Sri Lanka, on the other hand, can be written off as a program expense. However, there are runaway hits. Freakonomics authors reported that “Smile Train has performed more than 280,000 cleft surgeries in 74 of the world’s poorest countries, raising some $84 million [in 2007] while employing a worldwide staff of just 30 people.” There could also be increased regulation and oversight of non-profit reporting, and non-profits that do not meet certain goals could be downgraded by the government itself, and donations to these non-profits may be taxed. In terms of salaries and pensions, I suspect that anyone who has looked at Idealist.org or worked for a non-profit would agree that overall, non-profit spending on salaries is pretty reasonable. “I work for a non-profit” is universally accepted as a euphemism for sacrificing earning power to contribute toward a higher good.

While libertarians would love the existence of a charity premium, I don’t think the charity premium necessarily endorses all of the libertarian agenda. There are some services that non-profits or profit-driven organizations cannot tackle. Defense spending may be bloated, but simply for legal and liability reasons private entities wouldn’t be able to field even a defensive army, much less continuously invest in weapons that likely aren’t going to be used. Expensive long-term projects might not be able to bear the risk of a non-profit hitting a bad fund-raising year, so government deficit spending flexibility can be a good thing. Private administration of  justice would be profoundly unjust. And un-flashy places to invest, like building a road in poor rural part of American, would simply go undone without government.

Still, as long as there are clearly bloated areas of government spending, common stories of corruption, extensive government waste, and over-generous retirement packages, I conclude that the government should be making do with less. In that case, more utility comes from donating your money to a charity than to the government. More improvement of human life is obtained when a non-profit invests the 35% of your charitable donation that would otherwise be going to the Treasury.

So in this blog post we’ve discussed whether there is a charity premium on money spent. Return for Part 2, where I hope to propose a change to tax policy (above the deductibility of charitable donations) to take advantage of the charity premium.

Reading assignment for next post: Gates & Buffett campaign to raise $600 billion from America’s super-rich.


7 thoughts on “A Charity Premium and Premature Taxation, pt 1.

  1. Hey, very interesting post and I look forward to the next one – especially since I don’t usually hear the libertarian take on nonprofit organizations.

    A few further factotum from someone working in the nonprofit world though:
    – I’m pretty sure Howard Hughes is sitting on a large enough endowment and administer programs within their endowment draw-down so that they don’t ask for donations. period.
    – Smile Train is actually known to be a pretty problematic charity to donate to (see Givewell analysis: http://blog.givewell.org/2009/11/30/smile-train/) as are many other charities that supposedly give 100% of all their donations to their stated cause or whatever.
    – Furthermore, there’s actually been a huge push by some of the main charity watchdogs, including charity navigator, to move away from the % overhead model to a model more based on the charity’s actual effectiveness of meeting its impact. For more information about this, see their announcement here: http://www.kenscommentary.org/2008/12/measure-of-outcome.html. The post itself is dated late 2008, but as far as I know the process to actually close the information gap is still ongoing (with efforts like http://www.myphilanthropedia.org/ for example..)

    These facts don’t really denigrate your main point, but I thought you might find them interesting food for thought.

  2. Good post.

    I think you identify correctly that whereas there are a number of social protections that require the funding, legitimacy, and permanency of the state, there are many types of humanitarian aid that would likely be better served by private organizations.

    Most of us (in blue states, anyway) accept that the government has a right to tax us to pay for those services. And many private individuals choose to donate money or devote their time to private organizations that target specific problems.

    There are two broad ways, then, to take advantage of the “charity premium”. First, we can do our best to encourage people to donate more out of their income. Here, I agree, that increased transparency and oversight for non-profit organizations might simultaneously increase something analogous to ‘consumer confidence’ in donating and help maintain the “charity premium” itself. Fortunately, modern social media and the internet have made it much easier for these organizations to seek out potential donors.

    Second, as your next post addresses, there could be a way to “divert” some tax dollars towards private charities. This is a rather cynical approach that assumes that most people will only pay what they are legally obliged to, and thus will only give money to private charities if their net payment (to government and charity) remains roughly the same. Presumably, your plan would involve giving people some leeway towards directing a portion of their total tax payment. In an extreme version, I could see them getting some monetary bonus for giving to charities (i.e., $1.00 given to a non-profit with a certain “rating” of efficiency counting for $1.05 towards total taxes owed). This sort of incentive would encourage people to take advantage of the charity premium.

    I see some problems with this idea, however. It is never the truly wasteful programs that get squeezed out when tax revenue decreases. If the government is receiving less tax dollars, it will not cut back on Defense spending (the ultimate sinkhole of money) or try to pull Medicare away from the elderly masses. If the current recession is any guide, it’s things like teacher salaries, cultural initiatives, and social welfare programs that usually get slashed. And it’d be one thing if private charities could help ease some of that impact, but that is not always the case. We should keep in mind that many ‘wasteful’ government jobs are the only source of employment for many in the poorest social brackets.

    I generally consider myself fiscally pragmatic, so I admit that costly, pensioned do-nothing jobs in government must be ended. My concern is that even a good-faith effort to redirect government funds to more efficient private charities may not wind up weeding out government inefficiency, but rather programs that are simply more politically expedient to cut.

    I think there is some analogy here to school voucher programs, and my concerns are similar. Do we take funds away from public schools that are under-performing and allocate them to private schools? Does this lead to more efficient public schools? I’m not sure there’s an easy answer. I also see many of the peripheral arguments of THAT debate (Can diverted tax dollars go to supporting religious programs? What sort of oversight must be in place to guarantee that recipient charities are properly run?).

    There are certainly some complex legal issues, as well as the inevitable and unenviable creation of a new bureaucracy charged with monitoring the whole thing. In the end, perhaps there are better ways to encourage people to take advantage of the charity premium than trying to integrate it into the inefficient bureaucracy that is the source itself of that premium.

    Anyway, look forward to Part Two.

  3. Very interesting article David. I very much like the concept of a charity premium.

    Random thought: how do you think the existence of fundamentally stupid charities will affect your analysis? For example, the National Museum of Racing and Hall of Fame is a certified charity. The goal of this charity is to “bring[] the history and excitement of thoroughbred racing to the widest possible audience.” I passionately hate congress and taxes. But, I would much rather give 30 cents to a stupid bridge than help promote NMRHF. I guess it comes down to whose utility you are concerned with. If we focus on the person donating then presumably they will give their dollar to a charity they actually respect. But from the government’s perspective, (which is what matters) they have an incentive to only encourage donations to worthwhile charities. Determining whether or not a charity is fundamentally worthwhile is a very difficult question, which might explain why it is relatively easy to obtain charitable status. But, if we were to expand the charity premium it might be wise for the government to establish more rigorous criteria for determining when something is a charity. Especially if Thomas is correct. That is, a loss in government revenue that cuts science funding is acceptable only if the charitable money is spent on programs that are actually beneficial to society.

  4. And the above comment did not include religious institutions in the fundamentally stupid category. After a cursory search I was unable to find any information as to what percentage of charitable giving is sent to faith based organizations that primarily proselytize (compare American Tract Society to the Red Cross). If that percentage constituted a sizable section of the overall amount of donations to charity (which I suspect it does), that further undermines the argument for an expansive charitable exemption. And yes, I know that it would be easier to just strip purely religious institutions of their charitable status but that will, unfortunately, never happen.

  5. As an aside, I don’t think that the existence of the tax incentive for charitable donations implies that we intuitively believe in a charity premium. I think many people may attribute the natural dead-weight loss of taxation as a justification for the tax incentive. Yes, the current tax incentive is not that strong, but I do think that the tax incentive probably encourages greater charitable donations than would otherwise occur. There are situations (for example when people are coming up on the Alternative Minimum Tax, or their income level would kick in a higher rate of capital gains tax) when charitable donations are positive EV as a result of the charitable donations deduction.

    I don’t know that I buy all of your arguments about how this plays into the libertarian agenda. Your argument about defense spending ignores that the vast majority of current US defense spending flows to private organizations (corporations and defense contractors) who do everything but staff the Armed Forces. There would be legal and liability problems with a fully private Army, but that’s not a libertarian agenda so much as an anarchist agenda. As for expensive long-term projects, that doesn’t seem to be true: you yourself cite the Bill and Melinda Gates Foundation which has successfully tackled several long-term projects as a non-profit organization.

    Finally, you note that: “un-flashy places to invest, like building a road in poor rural part of American[sic], would simply go undone without government.” Governments tend to go for the flashy (or at least the well-connected). Part of the charity premium comes from how governments pick bad and wasteful projects because of political incentives. If not part of the charity premium, that may at least be part of an explanation of the charity premium.

    If anything, you tease at the tension between libertarianism and egalitarianism more generally – that peoples’ preferences for voluntary donations may reflect collective action problems, that only involuntary taxation can fix. That is a fair point. If anything, though, that’s a question of political philosophy. As for how to better take advantage of the charity premium even if we do have involuntary taxation – well, the answer to that is simple, and reforms of that type have become very common all around the world, especially in the developed world. The answer is privatization, and to a lesser extent, public-private partnerships.

    The problem is that, as Thomas notes, the more you bring voluntary solutions to government, the more you sap them of the very things that make them efficient and effective.

    • Good points, Alex. I wanted to comment just briefly on why this does not support the libertarian agenda. For the flashy places to invest, the point is that nonprofits/private companies have a hard time with unflashy projects. If the government didn’t pave random, little-used road in the middle of Montana, you wouldn’t have a paved road, you would have a classic case of market failure. It’s not flashy for the government. It’s not flashy for charities. And it’s not profitable for private companies. In terms of the defense spending, even though private companies can handle the research once they have the large government contracts, no private organization could independently raise that amount of money because most of the projects are not profitable/valuable until we actually go into war.

  6. Pingback: A Charity Premium and Premature Taxation, pt 2. « stone soup

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