Why High Taxes Hurt Charities

People give less to charity when state taxes are high, a new report from the American Legislative Exchange Council finds.

The conclusion, though unsurprising to students of economics, is nonetheless relevant to policy decisions about how best to help the poor. Raising taxes to fund government social programs may end up taking away funding from more effective charity organizations.

In “The Effect of State Taxes on Charitable Giving,” authors William Freeland, Ben Wilterdink and Jonathan Williams document what happens to private philanthropy when states raise or lower taxes.

After examining different tax rates in all 50 states, the authors concluded that a 1 percent increase in the personal income tax burden leads to a .35 percent decrease in charitable giving per dollar of state income. When the authors include all state taxes (not just income), the effect more than triples. They found that a 1 percent increase in the overall tax burden caused charitable giving to fall 1.16 percent per dollar of state income.

State Factor_Charitable Giving_Figure 1

Source: ALEC

The report offers three reasons for the negative effect on philanthropy. First, higher taxes cut into people’s take-home pay, making charitable giving more difficult. Second, higher taxes can reduce future income by hindering economic growth. Finally, taxes sometimes “crowd out” charitable giving as people feel they have already done their part toward helping others.

Numerous studies and policy experts have recognized that nongovernmental organizations, including churches and faith-based charities, secular nonprofits and even for-profit corporations tend to have more success combating poverty than large, bureaucratic government agencies. Yet this point is often forgotten in tax policy debates, which often assume that cutting taxes will deprive the poor of life-saving services.

“Civil society may well appropriately—and perhaps more efficiently–fill necessary gaps in public needs that might happen to arise alongside a back stop of more money in taxpayer pockets, more economic growth and a government that provides for core social needs,” the report argues.

With 1.5 million tax-exempt organizations in the United States, there are ample opportunities for Americans to support just about any cause they like. Charities are forced to compete for money and ensure effective outcomes. Inflation-adjusted charitable giving across the country has increased consistently over time, except during the recession.

But charitable giving varies considerably by state, and the ALEC report helps to shed light on how tax rates influence those differences.

State Factor_Charitable Giving_Figure 3

Source: ALEC

The states that give the most to charity as a percentage of income? Utah, Wyoming and Georgia.

Bringing up the rear of the list were New Hampshire, North Dakota and West Virginia.

States with no income taxes saw especially large increases in charitable donations. “In every category, over each time period, the nine no income tax states grew their rates of charitable giving more than the nine states with the highest income taxes,” the authors observe. 

From 1997 to 2012, charitable giving in the 10 states with the highest tax burden grew 27 percent. But giving grew twice as fast in the 10 lowest-tax states. “The trend in these results is clear; the states with more pro-growth tax and fiscal policies tend to also have higher rates of growth in charitable giving,” the authors said.

Jonathan Williams, one of the report’s authors and vice president of the ALEC Center for State Fiscal Reform, said he hoped the report would “start a conversation about what steps state policymakers can take to encourage tax competitiveness, economic opportunity and philanthropic donations.” Americans are a generous people. The more public policy that encourages private generosity, the better.

Daniel Huizinga is a columnist for Opportunity Lives covering business and politics. Follow him on Twitter @HuizingaDaniel.