In a recent discussion of President Trump's proposed tax plan Treasury Secretary Steve Mnuchin and National Economic Council Director Gary Cohn guaranteed that the charitable deduction would be among the few deductions protected.
While this is great news to many in the nonprofit sector, as the charitable deduction encourages charitable giving, three proposed changes to the federal income tax could still negatively impact charitable giving:
1. Increases to the standard deduction
Secretary Mnuchin and Director Cohn described a plan that would double the standard deduction, making it more attractive to many taxpayers. However, this would reduce incentives for charitable giving because these changes would reduce the number of taxpayers who itemize their deductions, a number already on the decline.
The charitable deduction is only allowed to taxpayers who itemize their deductions. The Tax Policy Center estimates that in 2017, only about 26 percent of taxpayers will itemize. Put simply, if fewer people itemize, fewer people will have the tax incentive to give.
Although the evidence is mixed on the degree to which donor behavior is shaped by this incentive, research suggests that higher-income households are more likely to itemize and are among the most likely to respond to the tax incentive.
2. Reductions to other itemized deductions
Director Cohn also mentioned that along with the charitable deduction, “homeownership and retirement savings will be protected, but all other tax benefits will be eliminated,” without providing further details. The charitable deduction does not operate in isolation. Rather, taxpayers consider the value of all deductions they qualify for when deciding whether to itemize.
Changes to other itemized deductions, particularly the elimination of the state and local tax deduction, because of its size, would significantly decrease the overall number of itemizers.
3. Reductions in tax brackets
The proposed tax plan would also reduce the current seven tax brackets to three (a 10 percent, 25 percent, and 35 percent). For some taxpayers, this will lower the value of the charitable deduction, making it less attractive.
For instance, someone in the current top 39.6 percent bracket saves $39.60 on an additional $100 claimed in charitable deductions but would save only $35 in Trump’s proposed 35 percent bracket. The effect is less clear for the other rates, as the bracket widths haven’t been specified, so some may face lower marginal rates and some higher ones, as some people may face higher marginal rates even if their average rate goes down.
Ultimately, although many in the nonprofit sector appreciate the administration’s efforts to leave the charitable deduction untouched, it is important to disentangle the effect of that promise from the real and important impacts on charitable giving that could arise from other proposals in the tax plan.