The Administration's 2010 and 2011 budget outlines contain a proposal to cap the value of itemized deductions at 28%, for high-income taxpayers. In the 2010 plan, the expected revenue was dedicated to addressing health care issues. Other revenue sources have been proposed for this purpose and the current proposal is part of the Administrations tax provisions for upper income taxpayers. The itemized deduction cap has generated considerable concern about its potential negative effect on charitable contributions, especially in light of the difficulties charities are having during current economic conditions. The proposed tax change, however, would not go into effect until 2011 and could actually increase current contributions in the short term. Thus, it is the longer-term, or permanent, effect on giving that is considered in this analysis. The analysis also considers the effects of other income tax changes and of the estate tax. Deductions normally save taxes at the marginal tax rate. If a taxpayer's top bracket is 35%, a dollar of deduction would lower taxes by 35 cents. The proposal would limit the reduction to 28 cents. Taxpayers claim deductions for charitable gifts when they itemize. Most taxpayers (70%) do not deduct their contributions because they take the standard deduction or in some cases do not file tax returns. In addition, the provision would affect only the top two marginal tax rates, which affect only about 1.4% of returns. Limiting the value of itemized deductions or converting deductions into credits is not a radical idea. The Congressional Budget Office, for example, discussed converting deductions into a credit in its 2009 Budget Options study. President Bush's Advisory Panel proposed to apply a credit to mortgage interest deductions and eliminate tax deductions although it would have retained and extended the charitable deduction. The reason for proposed credits and caps on itemized deductions is that itemized deductions create subsidies that differ across income classes. For the 70% of households that do not file returns or file returns but do not itemize, there is no subsidy. For returns that do, the subsidy rates vary; the lowest income taxpayers receive a subsidy of 10% to 15%, while the highest income taxpayers have a subsidy rate of 35%. In evaluating the proposed contribution deduction and its implications for charitable giving, this report first compares the magnitude of the proposal with past tax changes. The lack of any clear indication in historical experience of powerful effects of tax changes suggests a small response. The following section provides calculations of the consequences for charitable giving, which are estimated based on the share of giving that is affected by the cap, the magnitude of the price change, and the elasticity (behavioral response to tax changes). It also considers the effects of other income tax provisions in the budget and the effects on different types of charitable organizations. The study also discusses the role of the estate tax. It concludes with discussions of policy trade-offs and alternative policy options. Some insight into the expected impact of the deduction cap might be found by comparing tax changes to past tax revisions. The price of charitable contributions for itemizers is (1-t), where t is the tax rate at which contributions are deducted. For example, if the individual is in a 25% tax bracket, the tax price is 0.75, indicating that a taxpayer has to give up 75 cents for each dollar of contributions. That is, if the taxpayer in that bracket contributes a dollar, he or she saves 25 cents and only loses 75 cents that could have been used for other purposes. The tax price of giving is affected by a cap on the rate at which deductions occur but is also affected by the marginal statutory rate. Consider the top tax rate. It has fluctuated substantially since the income tax was introduced in 1913, beginning at rates as low as 7% and rising as high as 92%. Starting in the mid-sixties, the top rate was 70% for many years (although it rose slightly with the Vietnam War surcharge). Beginning with legislation in 1981, the top tax rate has been reduced substantially. Effective in 1982, it was reduced from 70% to 50%. In 1986, it was further reduced to 28%. Rate increases occurred in 1990 and 1991, and decreases in 2001. Table 1 compares the magnitude of those past changes in tax price to the effects of the proposed itemized deduction cap. Two effects are considered for the cap: the effect of imposing a cap on the current (2009) top tax rate of 35% and the effect of imposing a cap on the top rate of 39.6% which is scheduled for 2011. The percentage changes in tax price in the 1981 and the 1986 legislation were very large compared with the current proposal. If their effects are compared with the proposal's effect with current tax rates, the 1981 legislation is over six times as large and the 1986 change is over four times as large. The combined changes are 12 times the size of the proposed tax increase at the top rate (where the main effects of the proposal will be directed). Tax rate changes differ from caps on deductions because they also have an offsetting income effect. This effect tends to be smaller than the price change, however, because of graduated rates, and in some cases were offset by other provisions. For example, the Tax Policy Center reports that allowing the individual rates to rise to their planned 2012 levels in the top 1% would result in an 11.6% reduction in tax price but only a 4.4% reduction in income. The 1986 Tax Reform Act, with one of the deepest tax cuts in the top rates, maintained the pre-existing revenue yield and distribution across income classes. Thus, it contained no income effects. Table 1 addresses rate changes that affected the top rate, but the 1981 and the 1986 tax changes also reduced marginal tax rates across a broad range of taxpayers. In addition, non-itemizers were allowed an itemized deduction in 1985 and 1986. Figure 1 shows the pattern of giving as a percentage of GDP over this period. There is no indication in this pattern of significant shifts due to tax rate changes. Contributions after 1981, despite tax price increases, remained relatively stable as a percentage of price. The small peak around 1986 is generally attributed by most researchers to a temporary rise in deductions reflecting a timing shift as tax cuts for 1987 and 1988 were pre-announced in the 1986 tax cut, but by 1989 contributions had returned to their previous levels. Contributions following the 1993 tax increase fell rather than increased. A more detailed discussion of the potential effects is presented in the next section, but this historical comparison suggests it is unlikely that a significant effect on charitable giving will occur. To estimate the effect on charitable giving arising from the itemized deduction cap, three elements are required: the share of donations affected, the percentage change in price for those donations, and the permanent price elasticity. As shown in Figure 2 , a relatively small share, 15.9% of all charitable contributions, would be affected by the itemized deduction cap (which affects 1.4% of taxpayers). According to the Tax Policy Center, the share of individual contributions that are subject to the two highest tax brackets are 4.7% for the current 33% bracket (36% in 2011 absent tax law changes) and 23.2% in the 35% bracket (39.6% in 2011 absent tax law changes). Thus a total of 27.9% of individual charitable contributions on itemized returns falls within these marginal rates. Some higher-income individuals will not be affected by this cap because they are subject to the alternative minimum tax, with a maximum rate already at 28%. There is already a limit on charitable contributions, which is often exceeded by high-income donors, and for some donors, contributions are not affected by changes in the tax rate for itemized deductions because they already contribute in excess of the maximum. Charitable contribution deductions cannot exceed a certain percentage of income (50% for ordinary contributions, less for gifts of appreciated property and gifts to foundations). The excess contributions are carried over to future years to be deducted, but for very large donations or for contributors who have large donations year after year, these deductions may never be taken. If they are, their value declines because of the time value of money. This effect is potentially quite significant among wealthy donors. One study of contributions from income and estate data found that the wealthy who appeared in the estate tax data contributed over a long period of time about twice the amount of their deductions claimed. The average adjusted gross income in this panel (covering 1987 to 1996) was $1.8 million. The relationship between contributions and deductions was highly variable from year to year, likely reflecting the importance of large one-time gifts. Another study reported the percentage of giving over the limits for a single year (1995) and for a panel covering 1991-1995. For the adjusted gross income class of $2.5 million or over, the percentage of giving over the limit was 27.6% in 1995, whereas for the panel, the percentage of giving over the limit was 34%. Adjustments for the fraction of contributions in the top two brackets not affected by the tax change are based on this data, using the 1991-1995 panel. The overall excess of contributions over deductions in this data, covering income classes of $200,000 and over, weighted by giving, is 18.7%. Based on the estate tax study, that the highest income class, which accounts for about half the excess, is assumed to never deduct the excess, while the remaining income classes deduct it the following year, which at a discount rate of 5% would cause a loss of 5% of the value. This is equivalent to assuming that about half the excess contribution's deduction value is lost This adjustment reduces the share of deductions affected in the lower income bracket from 4.7% to 4.5% and the share in the higher income bracket from 23.2% to 20.8%. Overall the share falls from 27.9% to 25.3%. Finally, the estimate is adjusted for the share contributed by individuals who itemize, estimated at 63.2% for the latest year available.