IMPACT OF TAXES ON CHARITABLE GIVING

We estimate the impact of taxes on donations using a large panel of middle-class taxpayers. Our specification allows estimation of the effects of habits, time shifting, and consumption smoothing on the time path of adjustment and produces plausible simulated adjustment paths to permanent and temporary anticipated tax reforms. We find that taxes determine both the longrun level and the timing of donations, so that, even though taxes appear to have long-run behavioral effects, estimates of these effects are exaggerated if one fails to estimate the rescheduling of giving in response to tax regime shifts. Our results challenge the view that tax deductions for charitable giving are efficient. In this paper, we estimate the effects of tax policy on charitable donations using a panel of 1,382 individual tax returns from the years 1979–86. We do so in order to provide additional evidence on the efficiency of tax incentives for giving, to better understand the time path of adjustment to new tax regimes, and to better reconcile observed giving behavior and the predictions of econometric models. The relation between charitable donations and federal tax policy has been explored by dozens of authors (as surveyed by Clotfelter (1985a) and Steinberg (1990). Almost all of these studies find that giving is price-elastic, so that tax expenditures (such as the charitable deduction or a similarly fashioned credit) dominate direct federal expenditures in support of charitable outputs. More recent studies using panel data strongly challenge that conclusion (Broman, 1989; Daniel, 1989; Frischmann and Lin, 1990; Ricketts and Westfall, 1993; Randolph, 1995), estimating price elasticities that are much smaller. Panel data estimates *Department of Accounting, Walker College of Business, Appalachian State University, Boone, NC 28608. **Department of Agricultural and Applied Economics and Department of Statistics, Virginia Polytechnic Institute and State University, Blacksburg, VA 24061. ***Department of Economics, Indiana University-Purdue University at Indianapolis, Indianapolis, IN 46202-5140. NATIONAL TAX JOURNAL VOL. L NO. 2 322 are generally more persuasive than estimates derived from cross sections or time series for three reasons. First, panels contain sufficient information to allow one to control for a variety of unobserved but nonetheless confounding influences. Second, panels that span statutory tax changes allow one to better untangle the independent effect of price and income on giving. Finally, panels allow one to estimate timing and other dynamic effects that are lost in cross sections and overly aggregated in time series. A panel study conducted by one of us and reported in this journal (Barrett, 1991a) appears to salvage the argument in favor of tax expenditures, with a point-estimate price elasticity of 0.78, insignificantly different from the traditional critical value or its more recent refinements (Roberts, 1987). 1 In this paper, we reanalyze that panel using a more fully dynamic specification. We find that the question remains open, as the revised long-run price elasticity is 0.47, with standard error of 0.28. Our new point estimate suggests that tax expenditures would be preferred only if a dollar of government spending crowds out more than 40.52 cents of charitable donations, although our confidence interval includes price elasticities that justify tax expenditures for more realistic levels of crowding out. Econometric analyses of giving have been controversial because predicted impacts of tax reforms often appear inaccurate. Davie (1985) notes that, despite reductions in the capital gains tax rate in 1978 and in the marginal rate on ordinary income in 1981 (and, hence, increases in the tax price of giving appreciated assets and cash, respectively), itemized contributions increased dramatically between 1973 and 1983 (see also Clotfelter (1985b) and Bristol (1985) for a continuing debate on Davie’s position). A more sophisticated analysis by Auten, Cilke, and Randolph (1992) finds some large disparities between actual donations in each of the years 1979–88 and the level of donations predicted by a crosssectional regression using 1979 data. To some extent, these disparities are due to changes in the age, marital status, family size, taxpayer profile (type of taxpayer who itemizes), and the definition of adjusted gross income (AGI) across the included tax years, but after adjusting for these factors, large disparities remain. They conclude (p. 289): “The typical cross-section regression model does not fully predict some of the observed systematic taxpayer behavior. Most notably, the regression does not account for the short-term timing effects observed in 1981 and 1986. The regression also does not distinguish between single-year income and permanent income. ” Most prior studies portray giving as a “static” activity, with this year’s giving determined by this year’s tax-price and income level. Clotfelter (1980) takes the first step toward estimating a more dynamic specification, introducing “habit persistence. ” This estimation technique allows giving to adjust slowly to changes in donor circumstances, either because donors form habits or learn of tax and income changes in tax laws with a lag. Broman (1989) takes the next step, adding a variable reflecting the expected future price of giving on the theory that tax changes may affect the timing as well as the level of giving. Barrett (1991a), like Broman, incorporates habit persistence and price expectations but uses the more efficient two-way fixedand random-effects panel estimators. In this study, we take the next steps, adding consumption IMPACT OF TAXES ON CHARITABLE GIVING