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Charitable Donations and Tax Incentives

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Johanna Francis and Jason Clemens

There are two principal competing theories on the relationship between charitable donations and tax rates. The most popular theory for explaining charitable donations suggests that higher marginal tax1 rates create incentives for individuals to donate to charity because the after-tax cost of donating is lower. That is, individuals are encouraged to donate because they will receive a larger tax benefit in a high marginal tax regime than in a lower marginal tax regime. This assumes that tax incentives motivate individuals to give to charity, and that tax incentives have a stronger influence on philanthropy than other factors, such as wealth, and one’s level of disposable income.2

A competing theory suggests that disposable income, or after-tax income (determined in part by average tax rates), rather than marginal tax rates, is the principal determinant of charitable donations. It does not preclude tax incentives, but suggests that generosity and charitable giving are natural inclinations that do not require tax benefits, and that charitable donations are more related to disposable income. Simply put, the greater an individual’s income, or the "wealthier" they are, the more likely they are to give to charity.

Assuming the traditional theory of marginal tax rates and charitable giving holds, we should observe more (number) and higher (value) levels of charitable giving in higher marginal tax jurisdictions. In particular, we would expect to observe a significant difference in charitable giving between affluent income earners in different regions based on their relative marginal tax rates. We would also expect to notice an adverse effect on charitable giving if marginal tax rates were decreased. The empirical evidence, however, indicates something very different.

Charitable contributions: A US-Canada comparison

Canada, in general, maintains higher marginal tax rates than the United States. For instance, in 1996, the top federal marginal tax rate in Canada was 29 percent (plus a 3 and 5 percent surtax)3 and was effective at $59,181.4 The top combined marginal tax rate - provincial income taxes are levied on top of the federal rate - in 1996, for individuals earning $75,000 or more in British Columbia, for example, was 51 percent.5

The United States, on the other hand, maintained a top marginal tax rate of 40 percent in 1996, but at a threshold income of US$271,000. If we assume that the traditional theory of charitable giving holds, we would expect to observe higher levels of charitable giving in Canada than in the US.

Americans contribute in excess of $125 billion annually to charity,6 or roughly US$1,017 on average.7 Canadians, meanwhile, donate roughly $4 billion, or Cdn $738 on average, significantly less than their southern neighbours. This basic comparison casts doubt on the applicability of the traditional theory of charitable giving.

Comparing the wealthiest: a case profile

Arguably, individuals who fall into the highest income bracket should have the most incentive to give to charity if the traditional tax incentive theory holds. The evidence in Canada does not support this - in each income bracket, the percentage given to charity was relatively constant, in the range of 1 to 3 percent of pre-tax income.8 Increasing marginal tax rates in Canada did not result in increasing donations to charity.

A recent study in the US indicated that the wealthiest Americans, those with annual gross incomes of US$225,000 or more, gave an average 8 percent of their after-tax income to charity last year.9 The wealthiest Canadians, those earning Cdn$250,000 or more, gave 1.8 percent of their after-tax income to charity, roughly one-quarter the amount comparable Americans donated to charity.

Figure 1 illustrates the relationship between total charitable donations and the top federal tax rate in Canada. It is evident from figure 1 that total donations10 increased as the top federal tax rate was falling, suggesting that higher disposable income due to lower marginal tax rates induced greater donations.

US experience: declining marginal tax rates and increasing donations

The US experience of the 1980s corroborates this interpretation of the data presented in figure 1 and creates further doubts about the applicability of the traditional marginal tax explanation of charitable donations. As marginal tax rates were decreased during the 1980s, from a top marginal rate of 70 percent to 33 percent, charitable donations increased by a total of 27.8 percent, or almost 4 percent annually between 1982 and 1989. Thus, evidence from both the United States and Canada refutes the traditional notion of the relationship between high marginal tax rates and charitable giving.

Patterns of Donations

Additional evidence, based on the patterns of charitable donations, further corroborates the weakness of the traditional theory of philanthropy. For example, in 1995, 68.5 percent of Americans contributed to charities while only 39 percent of Canadians donated to registered charities, the exact opposite of what one would expect to observe if the traditional theory applied.

Further, an overwhelming 89 percent of Canadians on the latest Statistics Canada non-profit and volunteering survey indicated that they were not motivated by tax credits. In fact, less than half of the charitable receipts issued by registered charities in Canada were claimed in 1995.11

Interestingly, in the US, where individuals have the option to itemize their charitable deductions (and in fact must undertake this process if they are to claim them on their tax returns), only 29 percent of individuals choose to do so. Further, the available data from charitable organizations in the US suggests that almost half of the individuals who did not itemize their deductions donated to charity.

Given the fact that so many people in both the US and Canada donate to charities without accepting any tax benefit, it seems unlikely that marginal taxes in and of themselves can explain philanthropy to any great extent.

Disposable income and taxes

What we do notice is that in the US over the past 40 years, the growth in the level of annual charitable donations has closely paralleled personal income growth. In fact, charitable donations have remained almost constant as a percent of personal income.12 This seems to suggest, given the variable nature of tax rates in the US over this period, that individuals gave more when they had more.13

The tax bill for the average Canadian family has increased 1,286 percent since 1961.14 In 1997 alone, income taxes increased twice as fast as incomes.15 In fact, tax growth has outpaced income growth in every quarter since the last quarter of 1994. According to a CIBC Wood Gundy study, Canadians earning between $30,000 and $60,000 a year paid 8 to 9 percent more of their income in taxes than Americans in the same income range.

When we compare annual changes in charitable donations as a percentage of income, not only do Americans give more of their income to charity (between 2 and 4 times as much as Canadians), but donations have been increasing over the last 5 years in the US at a much faster rate than in Canada - an average annual rate of 9 percent versus 5 percent).

The fact that income taxes increased twice as fast as incomes for the last four years in Canada suggests that average and median charitable donations in Canada have lagged behind those in the US because Canadians have much less disposable income than Americans. Another way of putting this is that Canadians give less because they have less.

Conclusion

Reductions in the highest marginal tax rates in both the US and Canada in the 1980s did not result in the predicted collapse of charitable donations. Instead, over this period, donations (measured by the average size of donation) continued to increase. Since charitable donations have been a relatively stable percentage of personal income, it follows that the real growth of giving depends on the real growth of the economy. In other words, what matters most for increasing charitable donations is an individual’s real income. The evidence for the relationship between marginal tax rates and economic growth16 suggests that high marginal tax rates inhibit economic growth. Moreover, high taxation of savings and investment, e.g., capital gains tax, also inhibits economic growth and the growth of real income and, therefore, the ability of individuals to contribute to charity. If, as the evidence suggests, private generosity is more sensitive to disposable income and, in particular, to the growth in real income than it is to tax incentives, then a strong case can be made to implement a more growth-oriented tax regime to not only encourage growth, but also to encourage charitable giving.

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Notes

  1. Marginal tax rates apply to increments of income as opposed to average tax rates which apply to total income. For instance, the marginal federal tax rate for income over $59,181 is 29 percent; after this threshold each additional dollar of income is taxed at a federal rate of 29 percent. The average tax rate would be less than the marginal rate, since it applies to total income as opposed to only the last dollar of income.

  2. This assumes that the price effect of higher marginal tax rates outweighs the income effect of reduced disposable income associated with high marginal tax rates.

  3. The 3 percent surtax was eliminated in the 1999 federal budget.

  4. Karen Treff and David Perry (1996), Finances of the Nation 1996, Canadian Tax Foundation.

  5. Ibid.

  6. Michael Tanner, Civil Society to the Rescue, Cato Institute, June 16, 1997. Available on the web at www.cato.org.

  7. Perspective, "Decade of Greed," Investor’s Business Daily, October 10, 1996.

  8. Revenue Canada (1998), Individual Tax Statistics 1997.

  9. Debra E. Blum (1998), "Giving by Rich Rises to 8% of Income," The Chronicle of Philanthropy, Dec. 3.

  10. Average donation per capita also increased from 1984 to the present.

  11. Revenue Canada Charities Database, 1995.  Statistics Canada, Tax Statistics on Individuals, 1996.

  12. Alan Reynolds, Death, Taxes and the Independent Sector, The Hudson Institute, 1997.

  13. Stephen Moore, Less Than Charitable, Cato Institute, June 15, 1997, available on the web at www.cato.org; Independent Sector, The State of the Independent Sector, 1997, available on the web at www.indepsec.org/programs/research/almanac_overview.html.

  14. Joel Emes and Michael Walker (1999), Tax Facts 11, p. 37.

  15. Statistics Canada, The Daily, December 1, 1998.

  16. For example, see Joel Emes and Dexter Samida, Growth Tax in Canada, Public Policy Source, The Fraser Institute: forthcoming 1999; Robert Barro (1990), "Government Spending in a Simple Model of Endogenous Growth," Journal of Political Economy, vol. 98 no. 5, pt. 2; Edgar Peden (1991), "Productivity in the United States and its Relationship to Government Activity: An Analysis of 57, 1929–1986," Public Choice 69: 153-173.





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