House Ways and Means Committee Chair Dave Camp deserves credit for proposing a tax reform that takes on many special interests, something too few other elected officials are willing to do. But one provision mistakenly threatens the survival of most community foundations without improving the tax system or strengthening the charitable community.
The proposal would effectively eliminate most donor advised funds (DAFs), the major source of revenues to community foundations, so they could no longer provide long-term support for local and regional charitable activities. Instead, those funds would need to pay out all their assets over a period of five years.
DAFs support community foundations in two ways. First, donors pay about one percent of asset value to the foundation for sponsoring the fund. Second, community foundations distribute donor gifts to many local charities. By simplifying giving and reducing costs, they make it possible for people who are not wealthy to endow charitable activities.
Requiring a community foundation to pay out all its assets over five years is equivalent to telling the Ford Foundation that it, too, must pay out all of its endowment over a short period of time. But the draft bill only targets those with limited funds, while it leaves the really big guys like Ford alone.
Usually, I analyze tax policy as a disinterested observer. But as chair of a community foundation called ACT for Alexandria, I have a personal interest in this issue.
So let me tell you how this proposal would lead to the demise of many of our activities and, likely, the community foundation itself.
Each year we engage in a one-day fundraising effort for the charities of Alexandria, VA, a city of about 145,000 across the Potomac River from Washington, DC. This year we raised over $1 million for 121 local charities, and many contributions to support the effort itself, not just the charitable contributions themselves, came from our donor advised funds.
The fees we earned from the funds supported our program to train local charities on how to better use social media and do online fundraising. No one else in the community does this coordination and training.
In addition, several of our donors create DAFs, often small, to engage their families in philanthropic efforts. By doing so, they encourage a new generation to make charitable giving part of their lifestyles.
DAFs give donors flexibility to vary their gifts as circumstances change. For instance, one of our funds provides long-term support for schools in Afghanistan through U.S.-based charities, but there is no guarantee that any particular Afghanistan project would be strong enough to merit a direct permanent endowment. Other funds support a long-term examination of early childhood education opportunities in Alexandria, a project likely to change as needs change. DAFs or equivalent funds also allow “giving circles” that combine small gifts to assist an activity without having to create a new charity every time.
Without these funds, we likely would be unable to support a grant program for capacity building and training of local nonprofit leaders.
I doubt seriously that Chairman Camp’s staff saw fully how they would wipe out most community foundations and confine endowment giving only to the rich. By making it more complicated and expensive to engage in such activity, they would move almost all endowment decision-making to elite, often established institutions where the average citizen has little or no voice and where the operational expenses are greater.
Why are critics of DAFs so worried about someone having a say over an annual grant of $5,000 out of an endowment but not when the President of Harvard decides over time how to spend billions of dollars out of the income from an endowment?
There are legitimate concerns over how such donor advised funds should be regulated. It may even be possible to design a proposal for a minimum annual payout, though, if badly designed, such a limitation could curb the ability of some people to build up assets to make a major gift to try to achieve some large charitable purpose.
The very small literature I have seen arguing for this type of proposal entangles DAFs and community foundations with separable issues. For instance, one can argue about the extent to which givers to charity should be allowed special capital gains treatment. But those discussions go well beyond DAFs, and removing DAFs as a source of more endowed funds hardly targets the perceived problem.
Still, I also understand why tax staff and policymakers sometimes see charities as just another special interest. The charitable sector needs to go beyond its “we’re all good, leave us alone” mantra, and address real problems as they arise.
There are ways for Congress to reform the tax laws that would raise revenues and strengthen the charitable sector. But this DAF proposal would wipe out most community foundations, increase administrative costs, and raise nothing or almost nothing for Treasury.
This post originally appeared on TaxVox. An earlier version of this column stated that a fund-raising effort by ACT for Alexandria supported over 200 charities; the corrected number is 121 charities
This post originally appeared on TaxVox, the Tax Policy Center blog.
By proposing a far-reaching and detailed rewrite of the Revenue Code, House Ways and Means Committee Chair Dave Camp (R-MI) did something very few elected officials have done in recent years: He stuck out his neck and proposed radical reform. The initial press response has focused on politics and concluded that neither Republicans nor Democrats will be able to take on the special interests, that there is too much partisan gridlock, and that the plan is going nowhere.
But such responses largely ignore the history of successful reforms and forget that some policymakers do care about policy. If the goal is to conquer a mountain, someone has to start by building a common basecamp.
Almost any major systemic reform that does more than give away money creates losers. Someone always has to pay for whatever new use of resources the reform seeks—in this case, tax rate reduction and a leaner code with fewer complications. But politicians hate identifying losers. We voters punish them for their candor, which is why they nearly always increase deficits to achieve their goals and leave it to a future Congress to identify the losers who pay the bill.
With his full-blown tax reform proposal, Chairman Camp decided to lead and proposed repealing many popular tax breaks. There’s a lot I like and some things I don’t like in his proposal, but the simple fact is that a well-designed comprehensive alternative to current law can change the burden of proof. Change a few items, and each interest group argues that it was unfairly picked on. Put forward an alternative that takes on almost all preferences, and each interest then needs to justify why it deserves special treatment not accorded others.
The prospect for any reform is nil if no leaders do what Camp did and step up to the plate. The process is not one of instant epiphany. Rather it slowly builds support. Those who first propose change may increase the odds of success from 5 percent to 10 percent. Others who follow further improve those odds. If we reject out of hand all ideas that start with less than a 50 percent chance of success, we’d probably never reform anything.
It often takes modest support by others to move the process forward. In 1985, President Reagan and House Ways & Means Committee chair Dan Rostenkowski started the legislative process that yielded the Tax Reform Act of 1986 by simply agreeing not to criticize each other while the measure went through committee. Like Speaker Boehner today, Speaker O’Neill wasn’t enthusiastic about reform then, but Rostenkowski was able to proceed anyway.
In 1985, Rostenkowski knew he could pass a Democratic bill. But he knew it would go next to the GOP-controlled Senate Finance Committee. Each party would have a turn and a final agreement would come from a bipartisan conference committee. If House GOP leaders let Camp mark-up his bill now, Democrats would have their turn, at least this year, in the Senate. At least so far, both President Obama and senior Ways & Means Democrat Sandy Levin (D-MI) have avoided any major criticism of Camp’s plan, but one wonders if Democrats aren’t going to forego an opportunity, once again joining Republicans in deciding in advance that nothing substantial can be done, so it won’t.
Leadership is seldom about achieving results that can be predicted with certainly. More often it requires using your clout to change the process or reframe the debate in ways more likely to serve the public. It’s certainly about more than protecting your party’s incumbents in the next election regardless of the policy consequences.
When I served as economic coordinator and original organizer of the 1984 Treasury study that led to the ’86 Act, it was a time when books declared major tax reform the “impossible dream.” Sound familiar? In the face of that dispiriting commentary, I tried to encourage the Treasury staff with what I call the “hopper theory” of democracy: the more good things you put in the hopper, the more good things are likely to come out. By this reckoning, Chairman Camp has already won.
If we want successful companies to contribute to the economy fairly, what should we be asking them for? More corporate income tax? A higher minimum wage? Health insurance for employees? More profit-sharing for employees? Restricted-stock payments of highly paid executives, so they can’t succeed individually when they fail their workers and shareholders?
We’ve tried all these approaches, but at different times and in a discombobulated way.
The corporate income tax, which once raised far more revenue than the individual income tax, now applies mainly to multinational companies, which find ways to hide their income in low-tax countries. Domestic firms often avoid the tax altogether through partnerships or similar organizational structures.
The minimum wage has been allowed to erode substantially. I earned $1.25 an hour while in high school in the mid-1960s; if that amount had grown at the same rate as per capita personal income, high school kids and others would now be earning $20 instead of $7.25.
Health insurance mandates for many employers is our new form of minimum wage. The ACA’s $2,000-per-employee penalty for larger employers that do not provide insurance is essentially an additional “minimum wage” requirement of at least $10 an hour, either in the form of a penalty or health insurance.
Profit sharing was at one time touted as the way to instill better work habits and allow employees to share in a firm’s success. Many employees, however, put all their savings in that one investment and got stuck with huge losses when their firms declined.
A 1993 Tax Act limited to $1 million annually the amount of cash and similar compensation that could be paid to top executives and still get a corporate tax deduction. Post-reform, stock options flourished, as did a more uneven distribution of income within firms.
More recent proposals to reform the corporate income tax set minimum taxes on multinational companies, regardless of the country in which the income was earned; increase the minimum wage on all firms; bump up or reducing the mandate on larger employers to provide health insurance (by adjusting either what services the insurance must provide or the size of the penalty for not providing insurance); regulate companies to disclose how unequal their compensation packages are; and require executives, particularly in financial companies, to invest more in the stocks and bonds that couldn’t be sold immediately and would fall in value should their companies falter.
What drives all these proposals, I think, is the notion that large organizations only become that way by being successful and that they owe the public something in return for this success. At some point, almost all companies achieve their size by generating above-average profits and sales growth. The Wal-Marts and Apples and Mercks of today, the General Motors and U.S. Steels and Pennsylvania Railroads of yesterday, have or had more power and money than most. Did they get there only through the hard work and ingenuity of a few people who deserve most of the rewards? Or were they also lucky? The first out of the block? The beneficiaries of scale economies, where only a few companies would survive or the winner would take all? Did they get government help along the way, perhaps taking advantage of the basic research that served as a prelude to their development? Or the protections of a developed legal system, along with a bankruptcy law that limited their losses? If so, doesn’t that legitimize the discussion of how their gains might be shared, either with their own employees or the public?
If we truly want to create a 21st century agenda, I wonder if we could come up with better, more efficient, and fairer policies by asking the broader question than by piecemeal approaches. The corporate income tax, for instance, has been put forward by the chairs of the congressional tax-writing committees, as well as the president, as a ripe candidate for reform. Yet, however much I might favor such reform as a pure tax issue, it’s only a piece of these broader redistributional questions. Might it be better, for instance, to abandon the attempt to assess any extra layer of corporate income tax, and instead ask larger firms to take a greater role in accepting apprentices, hiring workers during a downturn, sharing profits with workers, providing minimum levels of compensation but not necessarily all in health insurance, and restricting the ability of their higher-paid managers to walk away with bundles even while their firms fail?
Obviously, the devil is in the details. But we should at least have the conversation.
Dateline: January 2014. Federal government shuts down completely.
Day 1. Mall, Washington, DC. Park Police decide shutdown again requires barring access to war memorials and the grounds of the Washington, Lincoln, and Jefferson monuments. Veterans rise up in anger and push back barricades. “If you’re furloughed, how can you keep us from entering the parks?” asks Joe Laploski, an Iraqi veteran from New Rochelle, NY. Park Police assign unpaid legal interns to determine whether Park Police should arrest themselves for working.
Day 2. White House. In hastily called press conference, President Obama announces major plan to deal with the national emergency. Enforcement on malls will be sustained, lest someone fall in the Tidal Basin and sue the government. Government debt will thereby be reduced, since Park Police cost less than those future lawsuits, at least on an expected basis.
Day 3. Capitol. Lights go out. Speaker Boehner lost underground. Democrats offer to fund search party, but, invoking the Hastert rule (requiring agreement by a majority of the majority party to act) and unable to decide whether they want to find him, Tea Party refuses.
Day 4. Longworth House Office Building. Democrats send search party after Boehner anyway. Find flasks of aged whiskey hidden by the late former Ways and Means Committee Chair Wilbur Mills two levels below the committee room where he presided. Debate ensues over whether imbibing is an essential government function. Inspired by former Occupy Wall Street supporters, Democrats decide to represent the activity as unity with the “99 percent,” who normally can’t afford such expensive booze.
Day 5. Treasury Department. Electronic payments of billions of government checks and bills stop. Secretary Lew called to emergency meeting at the White House to determine how much blame to assign to Republicans.
Day 6. Oklahoma City. Local Tea Party members claim the IRS is targeting them, citing delayed refund checks as proof. Back in Washington, House Oversight and Government Reform Committee decides to hold hearings in the dark.
Day 7. Near Capitol. Republican staffers gather at a local bar to debate how to get work done during the impasse. Consider asking the guy in charge of the lights for help, until they discover that position no longer exists because of the sequester. Boehner still missing.
Day 8. White House. President Obama plans national address during primetime. He asks the Democratic Party to pay for the speechwriters. Local TV stations refuse to broadcast the president’s speech unless their invoices for airing “Army Strong” recruiting commercials are paid.
Day 9. Treasury Department. Secretary Lew tries to issue checks to TV stations. In a 5-4 decision, the Supreme Court bars him from doing so until he lays out the precise legal priority for billions of unpaid bills.
Day 10. Princeton, NJ. Despite the worldwide recession induced by the shutdown, foreigners still flock to outstanding US obligations, and interest rates on US government securities tumble instead of rise. In a New York Times op-ed, Paul Krugman argues that at this low rate we should borrow all we can—unless it would pay for a Republican tax cut.
Day 11. Treasury Department. In response to the House Oversight Committee’s hearings, Treasury’s Inspector General issues report that Republicans were indeed targeted, indicating as proof that their delayed refund checks were bigger on average than those for Democrats. However, no crime was committed, he asserts.
Day 12. White House. President issues a statement that IRS targeting of Republicans is inexcusable. Fires top IRS data processing personnel and replaces commissioner with top executive from Avon Products with an unblemished record in taxes and data processing because she has never worked in either field.
Day 13. Sacramento. Governor Brown announces that millions of Californians are now insured under Obamacare. He asks that no penalties be assessed on those getting thousands of dollars in excess benefits since recordkeeping was impossible. On Meet the Press, Senator Cruz expresses amazement that the shutdown he favored affects every government program but Obamacare.
Day 14. White House. President Obama launches new peace initiative. He asks Hassan Rouhani of Iran and Bashar al-Assad of Syria to hire their own nuclear and chemical weapons inspectors, claiming that the U.S. shouldn’t have to pay to clean up other countries’ messes. President Putin offers to mediate and contribute Russian oil revenues.
Day 15. Capitol. Boehner found. Claims, like always, he knew exactly where he stood. Negotiates agreement with president on a continuing resolution to fund government until after congressional elections. Congress then shuts itself down until December 2014.
Day 16. Russell Senate Office Building. Before departing, Chairman Camp of the Ways and Means Committee and Chairman Baucus of the Senate Finance Committee issue a 6,700-page document with complex details on how to structure a major tax reform. Congressional leaders promise to take up issue immediately…in the next Congress.
No one quite knows what exactly Senate Finance Committee Chairman Max Baucus (D-MT) and Ranking Member Orrin Hatch (R-UT) mean when they say they will rely upon a “blank slate” as the starting point for tax reform discussions. But done carefully and with political artistry, taking advantage of their unique power, Baucus and Hatch could revolutionize how members of Congress negotiate the future of taxes.
But it’s all in the practice, not the theory. Done right, the strategy could reenergize the tax reform debate. Done wrong, it will be just another dead-end.
The idea of reforming the tax system from a “zero base” or building up from a blank slate is hardly new. And lawmakers always talk about everything being on the table. The challenge is in making it happen.
Baucus and Hatch must accomplish two goals. First, they must shift the burden of proof from those who favor reform to those who would retain the status quo. Second, they must force members to pay for their favored subsidy, denying them the opportunity to pretend it is free.
As a veteran of the Tax Reform Act of 1986, I always emphasize the crucial role of process. Sure, serendipity smiles or frowns unexpectedly on any endeavor, but the ’86 effort took off when Treasury, President Reagan, House Ways & Means Chair Dan Rostenkowski (D-IL), and Finance Committee chair Bob Packwood (R-OR) all put forward proposals that started with specific rate cuts and removal of many tax preferences.
Their plans were all somewhat different, but each changed the burden of proof. Lobbyists won many later battles, but now they were forced to explain why they needed to retain special preferences when others would not be so favored. Moreover, given a fixed revenue target, restored preferences had to be paid for. Lawmakers had to acknowledge that the price of adding back tax preferences was a higher tax rate.
Baucus, ideally with the support of Hatch, can put forward a “chairman’s mark” from which committee members can debate amendments. As both senators have suggested, that mark can be a relatively clean slate. Further, Baucus can require that amendments must not add to the deficit or change his revenue target, effectively requiring members to offer what are called “pay-fors.”
Normally, members debate items one at a time. Each adds a new subsidy without worrying about who pays for it—perhaps those currently too young to vote or the yet-unborn.
In dark times, politicians try to reduce the deficit by figuring out what tax increases or spending cuts will restore order to the budget. But identifying losers is immensely unpopular among voters, and politicians shy away from it. Worse, they blast those from the other party brave enough to provide details.
But if Baucus sets a revenue target at the beginning of this tax reform exercise, the dynamic shifts—from simply identifying winners and losers to explicit trade-offs. Winners and losers march together. With a blank slate or zero base, every restoration of a tax break requires higher rates (even an alternative tax), especially if there are few or no alternative preferences to sacrifice.
This process not only gives new life to a broad rewrite of the tax code but also makes it much easier to reform specific provisions. For instance, tax subsidies for homeownership, charity, and education can be much more effective and provide more bang per buck out of each dollar of federal subsidy. But politicians largely ignore such ideas because they create losers who scream loudly. Thus, the default for elected officials who fear negative advertising and loss of campaign contributions is to do nothing to improve these tax subsidies.
But when the burden of proof changes, a lobbyist can appear to be helping his masters simply by saving a subsidy, even if the net benefit is smaller than in the old law. After all, preserving a preference in some form is success relative to a zero baseline. Of course, as we learned in 1986, this argument grows stronger as the probability of tax reform grows. Can Baucus and Hatch change the burden of proof and force members to pay with higher rates for the subsidies they want to keep? They can certainly lead their committee and Congress in that direction, but only by specifying precisely a chairman’s mark that sets revenue and rates while slashing tax preferences.
If they do, Baucus and Hatch may force fellow senators to acknowledge that every subsidy must be paid for. And that, in turn, will open a window to design alternative tax subsidies that are fairer and more efficient. This sort of process revolution could remake policy in ways that extend well beyond tax reform.
Charitable organizations form a vital part of America’s safety net. Ideally, foundations would be able to make greater payouts in hard economic times when needs are greatest. Unfortunately, the design of today’s excise tax on foundations undermines and in fact discourages such efficiency.
Under current law, private foundations are required to pay an excise tax on their net investment income. The tax rate is 2 percent, but it can be reduced to 1 percent if the foundation satisfies a minimum distribution requirement. The dual-rate structure and distribution requirements obviously introduce complexity. The stated purpose of the tax in legislative history—to finance IRS activities in monitoring the charitable sector—has never been fulfilled.
In the recent recession, the impact of the excise tax was especially pernicious, as it penalized those that maintained their level of grantmaking.
How? As Martin Sullivan and I first described in 1995, the excise tax penalizes spikes in giving; under the current formula, a temporarily higher payout results in a higher excise tax when payouts fall back to previous levels. A foundation that reduced its grantmaking during the last recession would not be subject to an increased excise tax because the amount the foundation paid out would be measured as a share of current net worth.
One proposal would replace the excise tax with a single-rate tax yielding the same amount of revenue. While a flat-rate tax would remove the disincentive to raise grantmaking in bad times, it still raises taxes for some foundations and not others.
A related law applying to foundations is the required payout rate, now set at 5 percentage points. Many experts have debated how high that rate should be. The current rate is believed to approximate the long-term real rate of return on a foundation’s balanced portfolio of assets. However, if foundations follow a strict rule of paying out the minimum 5 percent every year, they, too, will be operating procyclically, paying out more in good times when stock markets are high and less in bad times.
If we wish foundations to operate more countercyclically—to pay out more when needs are greater—we need to address both the excise tax and the natural tendency, reinforced by a minimum payout requirement, to make grants and payouts as a fixed percentage of each year’s net worth.
Extending the charitable deduction deadline is a move with precedent: the government has used it to encourage giving following a natural disaster. President Barak Obama signed a provision allowing charitable donations toward the Haiti earthquake made from January 11 to March 1, 2010, to be deducted on 2009 tax returns. President George W. Bush signed a similar law allowing donations for tsunami relief made through January 31, 2005, to be deducted in 2004.
These provisions aim to increase giving at a time when need is critical. In reality, such temporary laws have limited effect because many do not know about these one-off incentives.
Consider instead the marketing possibilities of more permanent incentives to allow charitable deductions made by April 15, aka tax day, to be applied to the previous year’s tax returns.
By making what has frequently been a temporary measure into a permanent law, you eliminate the problem of trying to publicize brief windows of opportunity. Instead, people would come to expect that at filing time they would consider how much they would save by giving to charity.
Evidence suggests that, as in other facets of life, people are prone to making their decisions concerning giving at the last minute. The Online Giving Study finds that 22 percent of online donations are made on the last two days of the December, the last possible moment to claim a tax deduction for that year. Presumably this effect could be magnified if taxpayers were able to add to their charitable giving up until the last two days before they filed their tax returns.
Think of what such tax software companies as TurboTax or H&R Block could do by showing taxpayers directly how donating an extra $100 or $1,000 to any charity would lower their taxable income. The companies could even process the donation immediately through a credit card. If such a measure were enacted, I predict some foundations and charitable-sector collaborative organizations would immediately engage software tax preparation companies, other tax preparers, banks, and online giving organizations to figure out the best way to market this opportunity to the public.
This incentive would be by far among the most effective that Congress has ever provided in almost any arena, including existing charitable incentives. Why? Essentially, the revenue loss to the government is only 30 cents or so (the tax saving) for every additional dollar of charity generated. If people don’t give more, there are no losses, outside some slight timing differences. This is triple or more the estimated effectiveness of charitable giving incentives overall.
Marketing experts immediately grasp windows of opportunity. Back-to-school sales take place in September when families are thinking about school, grocery store advertisements near the weekend when more people do their shopping, Caribbean cruises in the winter when people are cold. The very best time to advertise charitable tax saving is when people file their tax returns.
This change would also add an element of certainty. Not knowing their income and tax rates for the existing year until it is over, people can only guess at the tax effect of any contribution they make to charity. When filing taxes, they can calculate exactly how much tax an additional donation would save.
A permanent law would also encourage all areas of giving instead of only the specific causes picked by Congress. Such targeted opportunities don’t necessarily increase people’s total donations: people are more likely to switch which charity they give to, not give more overall, when Congress highlights a particular charity.
In exploring this option for a number of years, I can find only one significant concern: the increased complication that is always induced by offering people choices (the actual tax-saving calculation, as noted, is actually simpler for many). Would people, for instance, mistakenly report their contributions twice, once for the past year and once for the current year? Would charities have trouble handling an extra checkbox in which taxpayers indicate in what year the contribution was intended?
If one is really interested in making the incentive better, this complication obstacle is easy to overcome. There are options here.
One would be to improve information reporting to IRS on charitable gifts. Only gifts for which charities give formal statements to individuals and the IRS itself could be made eligible. Noncash gifts might be limited in this case to those for which a formal valuation is provided to the taxpayers or, at least initially, excluded altogether. The information reports might only apply to those contributions over $250 for which charities are already required to provide statements to individuals. If charities don’t want to participate, they don’t have to.
Another, lesser bargain would be to experiment first only with online contributions for which software companies could send a report to the individual, charity, and IRS alike (this could include online checks for those banks and other institutions, not just credit card companies, who would be willing to participate). Other compromises along these lines are possible, and some of them on net are likely to improve compliance because of the integrated information system—a win-win strategy.
In separate testimony, I have offered a number of ways that this type of proposal could be incorporated into broader tax and budget reform so charitable giving is increased without any loss in revenues to the government.
With the United States still locked in a recession and the government cutting back its own efforts, what better time is there to encourage greater charitable giving?