Can a Charity Tax Credit Help the Poor?

Despite the lowest unemployment rate ever reported in Ohio, a record number of Franklin County residents turned to food pantries for assistance in 1997, 11 percent more than the year before. With more than 2,000 households requiring at least a month's worth of food--an unprecedented level of chronic need--food banks scrambled to raise the funds necessary to provide 14.2 million pounds of food. For the first time in Ohio history, the state legislature chipped in $1.5 million for the pantries, a gesture which could be seen as tacit acknowledgement that charities for the poor are being transformed from providers of emergency services to permanent suppliers of ongoing assistance. It's time to build that acknowledgement into public policy.

Nationwide, 21 million families once dependent on food programs as last resorts now rely on them for regular assistance. These programs can't keep up with the new demands. Emergency food assistance programs in many American cities are being forced by lack of resources to turn away hungry people they would have fed in the past. And the problem is likely to get worse: even as hundreds of thousands of poor people (one million in 1997 alone) lose food stamp aid due to welfare reform, charities serving the poor are projected to lose as much of 46 percent of their 1996-level federal funding by 2002. Ohio, for example, will lose $1 billion in food stamp benefits over the next six years. California is cutting back by $1.5 million per month (out of an original $9 million) on the food stamps it issues.

The crisis is not limited to food banks. Even as the number of clients seeking beds grows by the day (despite a growing economy and near record-low unemployment), government subsidies for most homeless shelters are dwindling. In 1996, the National Law Center on Homelessness and Poverty estimated a homeless population of more than 750,000 each night and a projected annual increase of 5 percent each year. Yet already last year an average of 24 percent of requests by homeless families were denied due to lack of resources, according to the U.S. Conference of Mayors. Of 59 cities receiving HUD support for homelessness programs, 76 percent have a shortage of emergency shelter beds and transitional housing slots. A study by the National Welfare Monitoring and Advocacy Partnership found that one in six former welfare recipients in South Carolina cannot pay for food after leaving the rolls and one in four cannot pay housing costs. In Wisconsin, welfare reform's touted vanguard state, shelters reported a 69 percent increase in the number of people turned away in 1996.

Thus even as their role as supplemental welfare providers is supposed to be expanding in post-AFDC society, charities are losing subsidies ($4.5 billion annually from the food program alone) from the Departments of Agriculture and Health and Human Services. Nonprofit charities for the poor are therefore in the untenable position of having to reduce the services they provide, sometimes dramatically, even as the number of people in need of such services is growing.

Two related solutions would help address this problem. The first is to redefine the meaning of "charity." Where the legal definition of charity once meant service to the less fortunate, today the word encompasses almost any nonprofit endeavor, from the local homeless shelter to the youth hockey fund to the neighborhood theater. The definition of the word is important because certain types of charitable status confer multiple tax benefits including untaxed profits for business income, special debt-financing options, and non-taxable donations from private individuals and entities. Poverty-servicing charities, because of their enhanced role in post-welfare society, should be granted special status. This change in the tax code would significantly restrict the boundaries of charity and allow for targeted proposals designed to increase the tax benefits enjoyed by nonprofits--but only to the advantage of the homeless shelter and not the theater.

The second step is to develop alternative means of funding charities for the poor. In the current political climate, direct service charities are unlikely to see their direct federal support restored anytime soon; individual taxpayers, therefore, must be encouraged to give more to these organizations. The way to do this is with a special charity tax credit.

A Charity Credit

People generally imagine that the local free health clinic or low-cost clothing store is financed mainly by good-hearted citizens through tax-deductible donations. The reality is different. Government is the single largest source of funding for human service nonprofits, providing almost half of all revenues for direct charity income. Thus recent government spending cuts have had a devastating effect. And while the average person thinks of the local homeless shelter, not the town symphony, as a typical charity, she is nevertheless more likely to give money to the symphony than to the shelter. Annually, only around $12 billion in private charitable donations went to organizations helping low-income families during the 1990s (and that includes donations to religious groups). More than $90 billion, in contrast, was donated to charities that did not serve the poor during the same period, according to the Nonprofit Almanac.

Tax laws group all nonprofits together, defining them as any organizations that provide services without regard to profit. A contribution to the symphony, according to Chapter 501(c)(3) of the Internal Revenue Code, gets the same charitable deduction as a donation to a food bank; both are categorized as contributions to charitable organizations.

We must modify the definition of nonprofits to favor those that serve the poor, so that the tax code no longer treats contributions to the symphony as equivalent to contributions to a food bank. A direct service charity would be required to meet one of two prescriptions. Either it would be organized and operated so that the majority of annual expenses are dedicated to poor relief; or it would be organized to solicit and collect gifts and grants to be distributed to qualified charities that meet the first requirement. Limits on what qualifies as a charity are an important starting point for targeted tax policies. Policymakers can generate legislation to aid the food bank without having to justify why the symphony will be left to fend for itself. (Establishing a minimum percentage of annual expenses to be spent on poor relief would prevent organizations from attempting to take advantage of the proffered exemptions and subsidies without a meaningful commitment to servicing the poor.)

But under current conditions, even an increase in charitable giving cannot entirely offset the impact of federal cuts in social welfare programs. Private giving to true charities would have to increase by at least 50 percent a year in order to offset government cutbacks. Under the existing tax code, private contributions can realistically only compensate for maybe 5 percent of the reductions in government spending; more conservative estimates place the figure as low as 1 to 2 percent. To meet the needs of the poor through private donations, contributions would have to increase by more than four times the current projected growth rate.

Is there any way to resolve this resource crunch? One possible solution is the charity tax credit (CTC). Although CTC legislation is not new, then-senator Dan Coats reintroduced it in 1995 to address the impact of welfare reform. Essentially, the tax credit encourages individual donations by allowing the donor to reduce her tax bill by some amount. Unlike the ordinary charitable deduction, which only allows a taxpayer to reduce the amount of taxable income, the charity tax credit is actually deducted directly from the final tax bill. For example, if a taxpayer in the 28 percent tax bracket donates $100 to the symphony and itemizes her tax return, she can reduce her taxable income by $100 and her tax bill by $28. With a 50 percent CTC, a donation of $100 to a homeless shelter or a qualified free medical clinic would reduce her final tax bill by $50. The tax credit increases the tax subsidies to genuine charities for the poor. Giving $100 to a homeless shelter would actually only cost $50; giving the same amount to the symphony would cost $72.

Donors who give with an eye to charitable deductions are more often those individuals who choose to itemize their tax returns. Thus taxpayers who opt for the standardized deduction are not usually enticed by the charitable deduction option. The charitable tax credit, on the other hand, would allow even those filing the 1040 EZ form to reduce their tax bill by contributing to qualified charities. By broadening the base of donors with an option that does not require tax itemization, the charity tax credit offers an excellent opportunity for charities to expand the private contribution pool. Wealthy donors tend to restrict their giving to their own ethnic and racial groups; the fact that the proposed tax credit doesn't require itemizing the tax form assures access to a wider pool of donors and maximizes the potential for diffuse contributions to a variety of agencies.

Embedded as a tiny ray of light in the ill-conceived Project for American Renewal, an attempt to strip Washington of almost all responsibility for the poor, Coats's bill sought to offer a 100 percent credit for contributions up to $100, with an incremental increase of $100 for each subsequent year, up to $500. Though no floor action was ever taken on the bill, the CTC may be the last, best hope for charities in dire need of more money. Through Coats's plan or a similar one, the CTC would generate an estimated $23 billion over the next five years, which would help substantially as charities cope with the growing stream of welfare reform refugees. Even a smaller credit would be valuable--it would certainly be more politically feasible. Decreasing the credit by as much as 50 percent from the Coats proposal would still produce revenues in excess of $10 billion dollars, which is more than direct service charities can currently anticipate receiving in government subsidies.

State governments have begun to see the logic of the CTC approach; more than 20 now operate some version of the charity tax credit. As you would expect, studies of these existing programs show that people give more to charity when the cost of giving decreases.

But while some policymakers favor a state credit, the federal tax credit is the better option. The funding lost to welfare reform is federal money, so the federal government should bear the primary duty of recompensing donors. In addition, because the state programs vary so widely--from youth rehab to community service support--charities easily run the risk of losing out to nonprofits not directly affected by welfare reform. More important, federal taxes are obviously much larger than state taxes--and donors would rather take a credit on their larger, federal tax bills.

Legislating the federal CTC into existence would be both a symbolic and a practical gesture. It would acknowledge the existence of the discrepancy between what's expected of direct service charities and what resources are available to them. And the revenue it generates would allow charities to meet the growing needs of the poor abandoned by welfare reform. What's more, freedom from government purse strings and the regulations that accompany them might allow greater opportunity for innovations in service delivery.

It is ironic that charities serving the poor should face diminished public funds just when they have become the only institutional recourse for the dislocated poor. If the federal government is going to rely so heavily on private charities to provide what it once did, then it must stop treating charities under the federal tax laws as merely supplementary providers of social services. After decades in which private charities assisted the government, focusing on contracted service delivery of federal and state welfare programs or on providing supplemental food assistance and emergency shelter, charities are now expected to deliver basic food and medical assistance, even to build low-income housing. When charities agree to fulfill the covenant broken by the public sector, they earn the right to demand concessions from both the private and the public sectors. Although the charity tax credit is a moderate first step, it is a necessary one if charities are going to accomplish what's now expected of them.

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