A version of this post originally appeared on Health Affairs.
From all the political discussion about health care, you’d think that government health policy lives or dies by what happens to the Affordable Care Act, or Obamacare. One side offers almost nothing apart from saying Obamacare must (somehow) be abandoned. The other side tells us that health costs, partly thanks to Obamacare, might be under control. Neither side faces up to the continuing dominance of health costs in projections of future federal spending.
Meanwhile, a recent study suggests yet again that spending much more on health care may do little to improve mortality and opportunity for the disadvantaged.
Like most debates that become political, the discussion tends to be numberless. Numbers aren’t always popular for those whose facts must fit their storylines, as opposed to those whose storylines evolve from the facts.
So what do the numbers tell us? Figure 1 shows that health care spending composes most of all projected increases in noninterest outlays of the federal government, but that Obamacare for those under age 65 is only a moderate cause of this growth.
Note: Because I focus on health costs, not on how we pay for them, calculations exclude payments made by taxpayers to support these programs, such as Medicare Part B premiums that budget analysts sometimes net from gross outlay payments. Allocation of costs or changes in costs over time because of Obamacare may exclude potential secondary impacts, such as a shift out of employer-provided health care or a change in Medicaid costs for people over age 64.
The health spending problem is still with us
Despite slower health spending growth, we have not solved our health spending problem. In 2026, the federal government is expected to spend (and subsidize through the employer coverage tax exclusion) at least $693 billion (in 2016 dollars) more than today for major health insurance programs. If we exclude the tax subsidies (as the exhibit does), this sum decreases, but only to $548 billion.
Excluding interest on debt, federal outlays for major health programs (excluding tax subsidies, which aren’t counted in outlays) eat up around 29 percent of today’s total federal outlays but about twice as much—56 percent—of the growth in total outlays between now and 2026 (figure 1).
Turning to the economy more broadly, for every additional dollar of real gross domestic product per capita expected 10 years from now, 20 cents will go toward supporting the rise in federal health insurance programs costs. And even these numbers significantly understate growth in total health costs by leaving out state and local health costs, other federal costs such as health research, and private spending on health care. Adding these other costs would indicate that health care continues to eat up a very large fraction of economic growth. Much of the confusion here about whether “health cost growth has slowed” occurs because lower economic growth tends to reduce the growth rate of all spending items, including health care, but not necessarily the share of growth absorbed by health care.
The relatively minor role of Obamacare
Obamacare has very little to do with any of this. If we include growth in tax subsidies for health insurance, Obamacare programs for those younger than 65, including Medicaid expansion and new health insurance subsidies in the Marketplace, entail only about 8 percent of the federal government’s cost for major health programs and 12 percent of the projected increase in annual cost within a decade. And even those additional Obamacare costs are offset partly by cuts established in the Affordable Care Act.
In contrast, growth in Medicare makes up half or more of all federal major health program spending and of the projected increases; the tax break for employer-provided insurance and the Medicaid program for those eligible before Obamacare also entail significantly higher costs than does Obamacare.
We have a long way to go in reforming health care and health care costs. Such reform must tackle all elements of what I have labeled our four-tranche system of federal subsidies: Medicare, Medicaid, employment-based subsidies, and the exchange subsidies established in Obamacare. We must also remember that the goal of reform is not simply to reduce costs but to shift resources to where public gains are expected to be higher, including preventing health problems before they arise.
Recently, advocates have revived and extended an old idea: that government should give everyone, regardless of their economic circumstances, a universal basic income (UBI). For instance, each single person would get a government cash payment of, say, $12,000, which is just above the official poverty level of $11,700. The benefit would reduce, or perhaps replace, current government tax and benefit programs aimed at low-income households.
The proposal raises some important questions about how government should help people avoid poverty and more generally support almost all of us who get government benefits of one type or another. While some critics wonder whether such an ambitious idea is affordable, I’m more concerned about whether society would be better off if government used the money to create opportunity for those who are struggling financially.
Progressive supporters of UBI see it as a way to eliminate poverty by redistributing more money from the rich. Those on the right say it could replace costly and administratively inefficient welfare-type programs. Adherents include Andy Stern, former head of the Service Employees International Union, and a growing group of Silicon Valley executives, such as Sam Altman, president of Y Combinator, a venture-capital firm which is funding a pilot program to research UBI in Oakland, CA.
The goals of reducing both poverty and inefficiency are worthy. But we want to be sure we don’t discourage work in an economy already facing unprecedentedly low levels of labor force growth. And while combining and simplifying programs makes sense, it can’t be done in one easy step.
Think about how complex low-income support programs have become since Milton Friedman and my mentor Robert Lampman of the University of Wisconsin first proposed in the 1960s a related idea, a negative income tax (NIT). A half-century ago, there was no federal earned income tax credit (EITC), supplemental security income (SSI), child credit, Head Start, special education, or Section 8 low income housing assistance. Congress was just enacting Medicaid, and national health care spending was less than a third of what it is today as a share of the economy. Supporters of UBI are not clear about what they’d do with these programs, or how they’d address pressures such as medical cost growth. Nor do they say how they’d deal with existing tax subsidies, such as the EITC, and the ways people are taxed indirectly as their eligibility for these benefits is phased out. By choosing the acronym NIT, Friedman and Lampman recognized that phasing out benefits as income rises is effectively a tax rate increase.
If they don’t replace current support programs, in whole or in part, supporters of UBI need to figure out how to pay for the new cash benefit. And critics, such as Bob Greenstein and Eduardo Porter, question whether we could afford such a program.
But in the medium term, a UBI could be funded simply by freezing the cost of current benefit programs and shifting scheduled increases to a cash program. Consider: Today, government at all levels provides about $35,000 annually in direct supports, including tax subsidies, per household. But that amount is due to increase by $10,000 to $15,000 by about 2026 and double within a few decades.
I’d prefer to shift larger shares of our direct support budget into promoting opportunity for work and saving, while promoting human and social capital. Such efforts would emphasize long-term earnings growth, wealth accumulation and upward mobility, whereas the UBI, with its focus on current consumption, would likely increase the inequality of market incomes by discouraging work.
Not that UBI supporters are wrong in stressing the inefficiency of existing programs. The type of efficiency they seek could be pursued in part by bundling programs together in a voucher that could be spent, say, on food, housing, or education—a design my Urban Institute colleague Bob Lerman and I called structured choice.
Despite the flaws of UBI, give its supporters some credit. They recognize both that the existing direct support system is quite flawed and we that do not have to be bound forever to a structure cobbled together over past decades in ways inattentive to current and future needs. There are just better reforms available than the UBI.
This post originally appeared on TaxVox.
Like many others, I have found it difficult to maintain a sense of optimism this campaign season. I’m less anxious about the candidates, whatever their limitations, than about how much we, the public, seem to tolerate—even at times support—campaigns whose modus operandi focuses on attacking others, whether other candidates, parties, or populations other than our own. I always worry when any of us (including myself) seeks an enemy on which to re-anchor a threatened political or religious belief or simply project discontent. At a minimum, this way of tackling our problems retards progress by failing to focus on what we can do together. More dangerously, it portends either disintegration or authoritarianism when it arises in decent times or periods of limited growth, thereby gaining potential to explode in times of true distress. If you want evidence, just look at the retreat from democracy in some developed nations throughout the 20th century or today in Turkey, Hungary, and, potentially, Austria and parts of Western Europe.
A day at the Boston marathon more than took away my gloom. I went there to cheer on my stepdaughter and a friend with whom I have worked at an Alexandria community foundation. It wasn’t just their fortitude and courage, as well as the efforts of thousands of other runners, that inspired me. My faith in humanity was restored by the extraordinary support of the public. There they were by the hundreds of thousands, from one end of the course to the other, cheering on everyone who passed by.
There were no class divisions for whom the bystanders cheered; everyone was a hero for trying. The runners ranged from the world’s best to those who barely had the stamina and body parts to survive—or maybe that’s my own projection of what I would look like out there. When the mobility impaired ran by, the cheers got even louder. No one was a stranger. Each public cheerleader only competed to see who could be loudest and support the most runners. Local bands found a street corner on which to play. Businesses gave out ice cream and other free goodies. Conversations flourished among absolute strangers. One of my companions broke into tears witnessing the community response.
Survivors of the 2013 terrorist attack also ran, making clear that fear—the only thing that can make terrorism succeed—would not deter them. Ken Ballen, the brilliant president of Terror Free Tomorrow, has long stressed that terrorists need a community to thrive or even survive. Such communities can form around, or in response to, blaming or distrusting others; they disconnect from the people and communities around them that don’t share their views. They are the exact opposite of what I observed of Boston that day. Thus, despite the very real pain in Boston, as well as San Bernardino, Fort Hood, Charleston, and other parts of the country attacked by individual terrorists or fanatics, our nation still thrives because of the strength and resilience of our communities.
So thank you, Boston. Your actions do more than inspire me. They drive me to undertake actions that include, unite, and ultimately strengthen the communities in which I work, play, and live. Whatever happens in the remaining campaign season, I can only pray that our leaders, whether newly elected or reelected, will learn from and follow your lead.
Despite their divergent policy views, Hillary Clinton and Donald Trump have many similarities that help explain their success in this election season. Pay attention: these lessons will be taken up, for better or worse, by future candidates seeking office in an unreformed system and by those in Congress, the states, or the political parties seeking reform after viewing with disdain the 2016 primary election process. With one exception, I list these common attributes in what I consider their rough order of importance to this and future campaigns: initial fame, use of identity politics through appeal to an excluded group, wealth, Ivy League pedigree, New York connections, presidential campaign experience, a sense of entitlement, and birth year.
- Fame. From the beginning, Donald Trump and Hillary Clinton were the most famous candidates in their respective parties, even before the media facilitated Trump’s further rise by granting him an extraordinary share of the attention. Correspondingly, the weakest candidates also tended to be the least famous. Initial fame has usually been quite important to both parties, though a bit less so on the Democratic side, where the Jimmy Carters and Barack Obamas have been able to build upon their appeals as outsiders. More unusually this time around, it didn’t seem to matter much where the fame came from, thus following the saw of our increasingly media-crazed world that bad publicity is better than none at all.
- Identity politics and appeal to an excluded group. Clinton and Trump—along with Cruz and Sanders—built their campaigns on a base of vocal supporters who felt underrepresented and denied a fair voice in government: liberal older women, men without college degrees or with declining job prospects, evangelicals, and the young. Yes, each of these groups is diverse, but each provided a surge in voters for the primaries as well as enthusiastic volunteers for the campaign trudge. The same might be said eight years ago about President Obama’s appeal to liberals of all colors who felt that his election would help complete a civil rights revolution. This pattern amends the traditional notion that the excluded group to whom one must appeal is the far left or far right of each party, or as Richard Nixon told Bob Dole, “You have to run as far as you can to the right because that’s where 40 percent of the people who decide the nomination are. And to get elected you have to run as fast as you can back to the middle.” With declining party identity, by the time of the general election the majority of the public now identifies with neither party nor that excluded group successful in the primaries. Themselves now largely excluded unless new coalitions can be formed, they will decide the final election by whom they vote against rather than for.
- Wealth. The Clintons are worth at least $50 million and perhaps more than $100 million. While Trump has been accused of exaggerating his net worth, it is plentiful enough. Or, as he told Good Morning America in 2011: “That’s one of the nice things. I mean, part of the beauty of me is that I’m very rich. So if I need $600 million, I can put $600 million myself. That’s a huge advantage. I must tell you, that’s a huge advantage over the other candidates.”
- Ivy League credentials. Hillary Clinton has degrees from Wellesley (one of the “little Ivys”) and Yale. Trump got his bachelor’s degree from the University of Pennsylvania. Cruz was educated at Princeton and Harvard, and Sanders received his degree from the University of Chicago. This trend isn’t new: Obama graduated from Columbia and Harvard, George W. Bush from Yale and Harvard, Bill Clinton from Oxford and Yale, and George H.W. Bush from Yale. All recent Supreme Court justices are Yale or Harvard Law School graduates. Don’t be fooled by stories about the declining power of old boy and old girl networks, or by tales that a strong education advances worldly fame or success, at least at the top of the pyramid, more than where you go to college, graduate school, or law school.
- New York connections. More money and more connections. Trump, a New York real estate magnate, and Clinton, a senator from New York, have been able to build upon their geographical connections to finance and wealth. All Republican presidents from Hoover onward, apart from war hero Eisenhower, have been from the big, moneyed states of California, New York, or Texas. Add Massachusetts to the list, and both parties have usually had a major candidate, if not actual nominee, from one of those four states for the past 80-some years. (Cruz, of course, is from Texas.) Bigger states also add to fame and electoral votes, not just money and connections.
- Presidential campaign experience. Everyone remembers that Clinton ran before, but you might not remember that Trump floated the idea of running in 1988, 2004, and 2012; in 2000, he won two primaries under Ross Perot’s Reform Party banner. Of course, here we have nothing new. Many presidents—including Kennedy, Johnson, Nixon, and both Bushes—previously ran for president or vice president or knew what to do from participating in their fathers’ efforts.
- A sense of destiny. Both major party candidates feel like they have worked hard and paid their dues, that others are conspiring to deny them something they have earned, and that they personally must acquire power to fight for our rights. Perhaps this is a requirement for anyone running for president.
- Birth year 1946-47. Malcolm Gladwell has commented on the power of small cohorts, ranging from late 19th-century industrial monopolists to leaders of the IT revolution, to dominate many thrusts forward. Consider, then, some birth years: Bill Clinton, George W. Bush, and Donald Trump, 1946; Hillary Clinton, 1947. Maybe this is the JFK factor: the excitement of the Kennedy-Nixon election and the resulting attraction to politics of those in late adolescence in 1960. But whether a random event or not, soon we will likely have 20 to 24 years of the presidency held by people born within either a 2- or 14-month period. Perhaps less repeatable than other attributes noted above. Or is it? Twenty-one senators were born between 1944 and 1950.
Over the past 30 or 35 years, income and government spending per household have both about doubled, but working- and middle-class Americans have seen much less improvement in their earnings, wealth, education, and skills than they did in earlier decades. The international economy and the concentration of power within the top 1 percent are major factors, but it’s hard to believe that we can’t do a lot better with the $60,000 in federal and state spending and tax subsidies we spend annually per household, or the $2 million in health, retirement, education, and other direct supports scheduled for each child born today. My recent study finds that the US budget is moving increasingly away from promoting opportunity for all.
At the same time, Hillary Clinton, Donald Trump, and almost everyone running for office ascribe to the notion of America as a land of opportunity while telling supporters they are being denied the opportunities owed them. But it takes more than rhetoric to climb out of our current political pit.
- First, the few programs that attempt to promote opportunity, such as work incentives and education, are scheduled to take a smaller share of available federal government resources. There is one major exception: large tax subsidies for housing and for employee benefits like retirement accounts continue to expand. However, by largely excluding low- to middle-income households, those programs show how today’s programs largely fail to promote opportunity for all. That is, they are not inclusive opportunity programs. Figure 1 summarizes these results.
- Second, if we wish to promote opportunity for all, we must carefully discern the outcomes pursued and judiciously measure how well programs achieve those outcomes. “Opportunity for all,” if left amorphous, lacks any prescriptive power, leads to claims that anything the government does or stops doing can promote opportunity, and, as long as the intended outcomes are unspecified, prevents assessing program performance. I suggest that opportunity for all is not simply an equity objective: it pursues outcomes centered on growth over time in earnings, employment, human and social capital, and wealth while it emphasizes inclusion, especially of low- and middle-income households. And I suggest that we can and should measure most programs by their performance on that opportunity standard, even if the primary standard by which they are judged—such as retirement, food security, or even defense—seems initially removed from that opportunity focus.
- Third, there’s tremendous budgetary potential for promoting opportunity whether the government increases or decreases relative to the economy. Realizing this potential doesn’t require moving backward on other fronts but shifting tracks, as from north to northeast, to also move forward on the opportunity front. The trick is to channel a larger share of the additional revenues provided by economic growth toward an opportunity agenda. Ten years from now annual federal spending and tax subsidies are scheduled to increase some $2 trillion (or roughly $15,000 per household), but essentially none of that growth goes to opportunity-for-all programs. Children receive almost nothing a decade hence, while interest on the debt rises significantly because we are unwilling to collect enough taxes to pay our bills as we go along.
When you look at these numbers, it seems clear that reorienting budget priorities could help provide opportunity in ways likely to promote equality in earnings and wealth. What is also clear, however, is that small ball is not going to get the job done when so much in the budget is moving in the direction of deform, not reform.
Total Outlays and Tax Expenditures for Major Budget Categories under Current Law
Billions of 2016 dollars
Source: Author’s tabulations of Congressional Budget Office data.
Notes: Public goods include such items as defense, infrastructure, and research and development that benefit the population broadly. Direct supports are programs and transfers that directly benefit households and communities, such as health care and education. Within direct supports, income maintenance programs such as Social Security, Medicare, and SNAP (formerly food stamps) protect a certain level of income and consumption, while opportunity programs aim to increase private earnings, wealth, and human capital over time. Largely inclusive opportunity programs benefit low- and middle-income groups, while noninclusive opportunity programs largely exclude them or provide them with fewer supports than upper-income groups.
President Barack Obama and Speaker Paul Ryan have proposed similar expansions of the earned income tax credit (EITC) for low-income workers without children. Their goal is laudable: to provide some modest additional income support for low-income workers currently excluded from the EITC. But as designed, their proposals would penalize many low-income workers who choose to marry or are married. Taking that step would not only provide a disincentive to marriage, it would be unfair to many married couples and erode support for the credit itself and for wage subsidies more broadly.
Fortunately, they can fix this flawed design by splitting credits for low-wage workers and benefits for children. Before I explain how, here is a bit of background.
The EITC, enacted first in 1975 under President Gerald Ford, has been expanded under every succeeding president and has broad bipartisan support. As cash welfare programs like Aid to Families with Dependent Children (AFDC) and its replacement, Temporary Assistance to Needy Families (TANF), have shrunk as a share of both the economy and the budget, the EITC has become a bedrock of the nation’s social welfare structure and the largest government cash support for those neither retired nor disabled.
About 97 percent of EITC benefits, however, go to households with children, particularly single parent families. The very small sliver going to single individuals through the so-called “childless worker” credit is limited by a maximum of less than $600 and is completely phased out at less than $15,000 of income, or less than what would be earned at a full-time minimum wage job. By contrast, the EITC can provide close to $6,300 in 2016 for a single parent with three children and is available to families with up to $48,000 of income ($53,000 in the case of married couples).
Obama and Ryan would double the childless worker credit and increase the income levels at which it phases out. A similar though higher level of credit was provided by the Paycheck Plus Project in New York City, which offers some individuals up to $2,000 and even allows a modest credit for those making up to $30,000.
There’s a glitch in these proposals, however, and it’s a big one. For instance, one report suggests that Paycheck Plus provides “more generous support to all low-income workers.” But in reality it doesn’t. Many low-wage workers who marry into families not only lose their own childless worker credit, but also reduce the normal credit available to their partner with children.
Here’s one example of how they lose out. A childless male making $11,000 qualifies for a credit of $1,011 under the Obama-Ryan model in 2016. If he marries a spouse with two children making about $20,000 and getting a credit of $5,172, they would get only one credit of $4,018, a loss of $2,165 from the combined credits of $6,273 they had before marriage.
As a result, the credit Obama and Ryan both support would penalize many married couples, while encouraging low-income couples to delay marriage and household formation. Because these penalties would be quite transparent to millions of married couples filing their tax returns, they would likely erode support for the EITC in general.
There is an ongoing debate about how much a marriage penalty actually affects decisions to wed, but there is little doubt that avoiding marriage is THE tax shelter for low- and moderate-income individuals.
The problem can be fixed by separating credits for low-wage work and benefits for children. My Tax Policy Center colleague Elaine Maag and I have proposed this separation as a way to expand work supports for both groups largely left out now: the childless worker and low-wage workers who marry. As for the single head of household, her current credit would be replaced by two credits: one for households with children and an additional low wage worker credit based solely on earnings regardless of children. They’d phase in and out at roughly the same income levels and add up to roughly what she received under the old EITC.
Meanwhile, both the single person without children and the low-wage worker who marries into a family could get the new low-wage worker credit whether or not the family has children. Married couples with two low-wage workers would usually be better off, as now the addition of a worker to the household usually typically adds to rather than subtracts from total household credits received. Though we phase out the low-wage worker credit for those married to high wage workers, these are families for whom any EITC marriage penalty would be a smaller share of total income and who, at their income levels, largely benefit from marriage bonuses from other parts of the income tax rate structure.
The structure of any EITC is hard to summarize in a short column. The main takeaway is that the President and the Speaker could fix their proposals to do what they say they want—cover those low-wage workers now largely left out. And they could do it without penalizing those who vow commitment to their partners and their children.
This post originally appeared on TaxVox and UrbanWire.
Presidential campaign slogans often appeal to progress. Donald Trump’s has attempted to trademark “Make America Great Again,” claiming authorship of the same theme Ronald Reagan used in 1980. Barack Obama got great mileage in 2008 around his “Yes, We Can” theme. Compare on an optimism scale Franklin Roosevelt’s “Happy Days Are Here Again” with Herbert Hoover’s “We Are Turning the Corner,” and you can see one more reason Hoover lost that 1932 election.
Though I believe we should be optimistic about our future, these slogans, along with presidential campaigns more generally, pretend to offer one easy solution to thousands of very complicated problems. At their most basic, the slogans and campaign promises appeal to the notion that if we elect the right president, then progress, greatness and happiness will follow right behind. And, if our candidate is elected, we can feel really good about our achievement: we’ve won the Super Bowl of politics.
By simply choosing between candidate A and B, suddenly we can solve not just how to administer thousands of programs that together spend close to $4 trillion a year, but how to improve economic growth; address social ills; stop international terrorism; deal with worldwide economic, social, and military forces that lead to mass migration—or at least stop them from spilling over our borders; pay people to retire for one-third of their adult lives; make sure that households don’t have to pay more than $5,000 for the $24,000 worth of health care they now receive on average; keep taxes low and debt sustainable; and, of course, regulate the environment, occupational safety, and the financial industry, among others.
But where do we fit in? Do we solve the country’s problems by increasing our benefits from some government programs? By lowering our taxes? That’s what the campaigns tell us. We’re going to get more from or pay less to government AND make the world a better place along the way. Gosh, we’re good.
Identify, if you will, one candidate for president or Congress who doesn’t tell at least 90 percent of us that we are about to get something more from government if we elect her or him. Oh, a few might get less—you know, those lazy people on welfare or those rich tax avoiders who aren’t going to vote the same way as us anyway. Their losses will finance our gains, and $100 billion of higher taxes or lower benefits for a few will somehow cover $1 trillion worth of lower taxes (or higher benefits) for us.
The one-vote-solves-all mantra adds to our sense of dependence and incapacity to make the world better. What does it matter if we work harder or tutor or in other ways provide services and goods that others need? Why should we spend less on alcohol or fancy cars and donate the proceeds to some worthy cause when our contribution is just a drop into the bucket? Why should we fight terrorism by donating to the education of women in poorer countries when we can always send out more troops or bring them home, or raise others’ taxes or lower ours so the economy grows? Why should we gather in our community to address the social ills that threaten a significant portion of its children?
Why can’t others see the solution? We vote the right way, but they don’t; that’s why our problems aren’t solved. Sometimes we win, but then our successful candidate turns coat and fails to solve old problems while allowing new ones to arise. Or our favored son or daughter really tries when elected, but those others deny our democratically achieved victory from attaining its complete fulfillment.
It’s them again; it’s always them.
There is an alternative view. I firmly believe that what we are and what we achieve as a people derives from the sum total of what all of us do. Government can often help us combine our efforts, and, yes, government can block progress as well. Either way, it’s a damn poor excuse for our own failure to act well when we can and our tendency to blame others to excuse our own inaction.
So, yes, let’s engage fully in the elections. Let’s also be optimistic about the future when we live in a nation never so rich throughout all of history, and stand on the shoulders of those who went before us, who added to our store of knowledge, and sacrificed to make our own world a better place. At the end of the day, let’s also admit that progress derives from everyone’s efforts and reject wholeheartedly the dependency that derives from the notion that our role in advancing society comes mainly from flipping a toggle switch.
Mark Zuckerberg and his wife, Priscilla Chan, recently pledged to donate 99 percent of their Facebook shares to charitable purposes over their lifetimes. They are doing it through the Chan Zuckerberg Initiative, which uses a limited liability corporate structure.
Why not give to an IRS-approved charity, or a foundation created by Zuckerberg and Chan, instead? Two reasons leap to my mind, both shaped by nonprofit law. The first, which I fail to see in most commentary to date, is that generous lifetime giving by the wealthy can’t get much of a charitable deduction no matter how structured. Second, the Zuckerberg-Chan pledge falls into a class of efforts sometimes labeled “fourth sector” initiatives, which give much greater flexibility for how the money is used, including combining charitable and business purposes and lobbying for a favored cause—essentially what private individuals can but pure charities cannot do.
Economic Income, Realized Income, and the Charitable Deduction
In studies examining the behavior of those with significant wealth, other researchers and I show how little income they tend to realize, often 3 percent or less of the value of that wealth. That doesn’t mean the investors have earned such low rates of return. In fact, many like Mark Zuckerberg became millionaires or billionaires because they got very high returns. Most of their money, however, tends to be in stock or a closely-held business and, especially for those with only a few million dollars in total wealth, residences and vacation homes. As long as the wealthy don’t sell those assets, they won’t “realize” for tax or other accounting purposes the true economic returns or gains they achieve. And those gains can be substantially more than 3 percent: from 1926 to 2014, including during the Great Depression and Great Recession, stocks produced an average annual return of about 10 percent before inflation.
Related research examining the charitable activities of such wealthy individuals shows that most delay a huge portion of their giving until death. That is, they give from the wealth of their estates, not the income of their lifetimes. Why? Because tax law provides very little incentive to give huge donations to charity during a lifetime. Let’s suppose that Mark Zuckerberg and Priscilla Chan normally realize as income 2 percent of their estimated $45 billion wealth, or $900 million, this year. The charitable deduction is limited to 50 percent of yearly income, which in Zuckerberg and Chan’s case is $450 million; it’s only 30 percent ($270 million) if they want to give to foundation. Thus, if Zuckerberg and Chan give away more than 1 percent of their wealth each year, they run out of allowable charitable deductions. If in an average year they earn 10 percent on their wealth and give away only 1 percent, they are still accumulating much faster than they are giving it away, unless they consume billions annually.
Running out of charitable deductions doesn’t mean that the wealthy gain nothing from giving away money directly to charities earlier in life. Once assets are transferred to a charity, the donors don’t have to pay taxes on the income earned from those assets. But donors such as Zuckerberg and Chan would achieve only modest tax savings from early gifts to charity as long as their taxable income from the alternative remains a small percentage of their wealth. What also might be in play here, and I don’t fully know, is that the charitable side of the Chan Zuckerberg initiative will yield enough losses, transfers, and sales to needy individuals at below-market cost to offset any taxable income otherwise earned on the business side, so it can effectively avoid income tax just as well as an outright charity.
For Benefit Corporations and the Fourth Sector
So limits on the advantages of a charitable deduction provide a significant impetus for wealthy individuals to pledge money for charitable purposes without necessarily giving it to a charity. Donors may also think the flexibility they gain is substantial relative to any potentially modest tax costs. Giving to charity later is always an option, thus avoiding estate tax; meanwhile, other options haven’t been foreclosed.
Among the additional options at play is combining nonprofit and business activity. Among the many efforts of this type that get complicated in a pure charity setting are raising private equity; sharing real estate investment returns with low-income residents; running a business centered around training its workers and building up their equity rather than making profits for investors; investing in new drug research and pledging that the public, not investors, will garner any potential monopoly returns from some successful patent; or investing in green energy by granting some risk protection to private capital partners; and garnering research and development tax credits.
Some states have tried to create special rules applicable to certain “for-benefit corporations” that allow shareholders and charities to share returns. But, for the most part, the walls surrounding charitable money can’t be torn down. Federal and state tax and other nonprofit laws protect money that now essentially belongs to the public (with the charity as fiduciary), not to the donors.
If donors aren’t worried about getting a charitable deduction up front anyway, as is likely the case for Zuckerberg and Chan, the easiest route is to create a potentially profit-making limited-liability business. Meanwhile, donors can engage in all sorts of ventures without having their lawyers shouting “Stop” to each new creative idea because it might violate some charitable law. At the same time, Zuckerberg and Chan need a new entity since they can’t pursue their charitable pursuits directly through Facebook without soon running into problems meeting that corporation’s obligations to other shareholders.
If Zuckerberg and Chan decide that they want to lobby government, they also can avoid any limitation imposed on foundations or other charities.
These types of private initiatives, sometimes labeled as a Fourth Sector, push society in new, exciting, and yet-to-be-determined directions. As I’ve discovered when I raise money for charity, people will often consider giving away much more when asked to think about giving out of their wealth, not just their realized income. Fundraisers, take note: I don’t think we’ve even begun to tap this way of encouraging giving. Also, people often see new possibilities for enhancing charitable purposes when not confining themselves within the walls surrounding a typical charity, with entrepreneurs and venture capitalists often especially excited by the new adventure. Zuckerberg and Chan are merely two of the richer faces giving new attention to these broader movements.