Sunday, May 19, 2013

Donations to 501(c)4's are not tax-deductible. Good. Why are those to 501(c)3's?

 **The following is a revised and expanded version of a former post**

With the IRS "scandal" (and, yes, "scandal" belongs in quotes), we have seen an increased attention to the exemptions built into the tax code for various types of organizations.  In the story in question, the tea party groups had applied for 501(c)4 status, or determination as a "social welfare" organization.  I want to go over the definitions of 501(c)4's, 527's, and 501(c)3's to cover the poles of political activity among tax-exempt groups (other than labor unions, agricultural leagues, and business leagues).  After that, I will discuss the charitable deduction and why I think it is a flawed policy despite its popularity.

501(c)4's are tax-exempt organizations, but donations to 501(c)4's, albeit anonymous, are mostly not tax-deductible. The IRS defines 501(c)4's in the following manner:
Civic leagues or organizations not organized for profit but operated exclusively for the promotion of social welfare, or local associations of employees, the membership of which is limited to the employees of a designated person or persons in a particular municipality, and the net earnings of which are devoted exclusively to charitable, educational, or recreational purposes.
501(c)4's are allowed to lobby for specific pieces of legislation; such 501(c)4's are often called "action funds." (That's why every think tank and issue group has an "action fund.") The IRS describes such a group in the following manner:
(a) its main or primary objective or objectives (as distinguished from its incidental or secondary objectives) may be attained only by legislation or a defeat of proposed legislation; and (b) it advocates, or campaigns for, the attainment of such main or primary objective or objectives as distinguished from engaging in nonpartisan analysis, study, or research and making the results thereof available to the public.
501 (c) 4's are allowed to intervene in political campaigns as long as their "primary" activity is still the promotion of the general welfare.  This is why 501 (c) 4's with expensive tax lawyers can design their tax returns to show exactly 49% campaign activity. 
 
527 organizations include political committees (including state, local, and federal candidate committees), political action committees, "Super PACs," and political parties.  527's are mostly tax-exempt because, although their investment income is subject to the federal income tax, the IRS does not include the following sources of revenue in their taxable income:
(A) a contribution of money or other property,
(B) membership dues, a membership fee or assessment from a member of the political organization,
(C) proceeds from a political fundraising or entertainment event, or proceeds from the sale of political campaign materials, which are not received in the ordinary course of any trade or business, or
(D) proceeds from the conducting of any bingo game (as defined in section 513 (f)(2)),
527 organizations, unlike 50 (c)4's, have to publicly disclose their donors and expenditures. 527's can engage in candidate election advocacy, but can only have minimal engagement with legislative advocacy and non-election-related public advocacy.  Donations to 527's are not tax-deductible. 

501(c)3's represent the opposite pole of political activity among tax-exempt groups.  This group includes your standard non-profits, houses of worship, foundations, museums, colleges, etc.  The IRS defines 501 (c) 3's in the following manner:
Corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual, no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation (except as otherwise provided in subsection (h)), and which does not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office.
501(c)3's are prohibited from engaging in candidate advocacy.  They can only engage in limited legislative advocacy, but they are free to engage in public advocacy on non-election concerns.  Donations to 501(c)3's, unlike donations to 501(c)4's or 527's, are tax-deductible. 
 
**

Although 501(c)3's, 501(c)4's, and 527's are all tax-exempt organizations, only donations to 501(c)3's are tax-deductible, and the charitable deduction remains very popular.  According to an April 2011 Gallup poll, 71% of those surveyed opposed eliminating the charitable deduction as part of plan to lower the overall income tax rate, and 68% opposed eliminating it as a part of a plan to reduce the budget deficit.  Despite its popularity, the charitable deduction, as I will argue, is a flawed policy.  I will focus particularly on both libertarian and social democratic objections.

We should begin by establishing a definition of charitable giving.  First, charitable giving is a private act; it refers to what an individual does with his/her own money in contrast to what a government does.  Second, the recipient of the money is doing work that the donor expects will advance a vision of the good society, broadly defined.  Third, charitable giving differs from investment in that the donor does not expect pecuniary return on the funds contributed.  So, taken together, charitable giving refers to the private contributions of individuals to institutions that they believe to be advancing the good of society and from which they expect no pecuniary return.  Moreover, in connection to the tax code, we are talking about large contributions;  the IRS only recommends itemization in such cases.  Those who make small donations are more likely to take the standard deduction.

The charitable deduction as a part of a tax code enables an individual to subtract charitable donations from his/her total income, thus reducing the total amount of money on which s/he has to pay taxes.  The simplest set of justifications for the charitable deduction would also be threefold: (1) that individuals as private actors know better how to spend their money to improve society than they do as a collective, (2) that the government cannot by itself address the problems of society, and (3) that the government should provide incentives for private individuals to contribute to the betterment of society.

Even though the first two justifications clearly echo a libertarian philosophy, the last justification runs against libertarian principles, specifically the central claim that the government should be blind to the economic, social, and political activities of its citizenry.  According to libertarians, the income tax is a violation of liberty first and foremost because it removes the blindness to individual economic activity and requires the release of information on economic gains for government oversight.  However, viewing the income tax as a given, it should  be as neutral to the economic activities of private individuals as possible.  Consequently, all tax credits and deductions would be problematic because they consist of actions taken by the government to encourage or discourage private economic actions.  Why should the government's tax collector care whether an individual does or does not contribute to charity? Additionally, why should the government have the right to know to which institutions an individual chose to allocate funds, especially in cases in which no economic gain will result?

A libertarian, or perhaps more appropriately now civil libertarian, argument would continue on church-state grounds.  Among the IRS list of qualifying organizations are "churches, a convention or association of churches, temples, synagogues, mosques, and other religious organization."  The charitable deduction in such cases, then, becomes the equivalent of a government subsidy to religious institutions.  The government is not "establishing" a religion per se, but it is subsidizing contributions of houses of worship--a violation, in my opinion, of the separation of church and state.
The charitable deduction also leads the government to subsidize organizations that are viewed by many as hate groups. Take, for instance, the Westboro Baptist Church, which both the ADL and the SPLC consider a hate group.  White nationalist Peter Brimelow's VDARE Foundation is a registered 501(c)3, meaning that the government effectively subsidizes donations to that organization as well.

The social democratic argument against the charitable deduction stems from opposition primarily to the first aforementioned justification for the charitable deduction and partially to the second justification. In other words, the social democrat does not agree with the claim that private individuals know how to allocate large funds better than the government (those individuals taken together in a collective participating in deliberation) can, and even though the social democrat acknowledges that the government cannot solve all problems, s/he still believes in the power and efficacy of the government as an actor for social betterment.  Although individual wisdom can guide small purchases--the government should not buy your shoes for you, it is not the best guide for the disbursement of large funds with more far-reaching effects. In this context, the charitable deduction is taking money away from the social services that the government provides, depriving it of the opportunity to shore up funding for existing programs or innovate with new ones.  Moreover, especially as they relate to universities, such large private donations can create undue influence on the nature of research itself.  The extra funds in the pool of general revenue gained from the elimination of such a deduction could be used to provide a more robust funding base to universities, guaranteeing their freedom to work for the advancement of the scholarly disciplines and for the public good.  Despite the occasional use of charity as PR or as a tool to advance self-interest, charitable contributions are more oft than not quite noble; however, they are not adequate substitutes for the actions of government and should not be treated as such.

"Yes, I understand both of your points.  But people won't donate to charity without the charitable deduction," you might respond.  To believe so is to have very little faith in human beings.  Are people so selfish and stingy that we need to dangle dollars in front of their face in order to break the vise-like grip they have over their wallets?  Isn't the virtue of benevolence that one expects nothing in return?  Shouldn't the desire to contribute to the betterment of society as an individual be something inculcated in the young through parenting and schooling and, thus, need no financial incentive?  I would not be willing to say that charitable donations would not drop in the face of an elimination of the charitable deduction because I have no empirical proof either way, but I think it would be a sad reflection on human character if they did.

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