Personal Finance: The Alms Race

Why the US loves the alms race: Giving to others is not always about the tax break.

At what age does giving it back become more important than getting it? Thirty-six? Fifty-eight? Seventy?

It is different for everyone but most people discover at some point that social service and charity have taken hold of those corners of the brain once devoted to returns on investment. Suddenly there is a desperate need to give - and soon.

This is why some of us felt relief when George W. Bush, president, announced plans to retain the tax deduction for charitable gifts. No matter what overall tax reform he might undertake, the president said, he still viewed the preservation of tax incentives for charity as crucial.

The reality, however, is that we tend to overestimate the value of this itemised give-back. As Blanche Lark Christerson, a director at Deutsche Bank Private Wealth Management, points out, under current law you can lose up to 80 cents on the dollar of the value of such itemised deductions because they start to phase out when family income reaches Dollars 142,700.

Yet much giving happens above that level. In the end, specific tax breaks do not make people give, the impulse to give is what makes them give. That impulse comes when people believe two things: that they can spare the cash, and that their giving will improve both their own lives and those of others.

"For the past four decades, total charitable giving has remained fairly constant at about 2 per cent of gross domestic product," notes Adam Meyerson of the Philanthropy Roundtable, a national association of donors and foundations.

"This suggests charity is best increased not by any specific tax incentive but rather by boosting economic growth." It also suggests that lower rates overall, the sort that promote growth, are what yield the maximum charity dollars.* The best-known evidence for this argument is the contrast between the relatively charitable US and continental Europe, where non-profit and charitable giving are both substantially weaker.

"American foundations try to work multilaterally to address global problems. But they find they end up working unilaterally. That is because they do not find the donors in continental Europe that they expected to find," says Jack Anderson, Paris-based partner at Ernst & Young.

On the continent, the social-welfare state has smothered charitable impulses. People have less cash to spare because they pay so much in taxes. Europeans also see less need to give. Why give if the Sozialamt will do it?

The difference is also visible when you look at the US. Following the 1980s tax cuts, many observers argued that charitable giving would go down. After all, the cuts - from a top rate of 70 per cent to one of 28 per cent - reduced the relative tax advantage of charity. Nonetheless, giving increased, due to the boom that followed the rate cuts.

The same trend is evident in individual states. This month the Boston-based Catalogue for Philanthropy, a non-profit that researches charitable attitudes, published its annual Generosity Index.

The index looks at the charitable giving of citizens relative to their average income, and ranks the results by state. A number of states on the generous side are fast growers that are relatively friendly to business and/or individual taxpayers: Texas (no income tax); Florida (no income tax); South Dakota, ranked best out of 50 for business climate by the Tax Foundation. This, even though the average income in some of the generous states is low.

Conversely higher-tax states - New York, California, Pennsylvania and patrician Massachusetts - are on the stingy side of the Generosity Index. There are exceptions: the citizens of Utah, a relatively high-tax state overall, are big philanthropists. Low-tax New Hampshire gives little. Still, the index makes clear that what is good for business and personal wealth can be very good for charity.

One can even go farther and argue that in the hierarchy of capital accumulation, government is worst, non-profits are second-worst, and the private sector is best. Members of Yale's class of 1954 decided to withhold gifts to the university, which had - at the time they looked - a poor investment record. Instead, the class invested themselves. About Dollars 75,000 in seed money appreciated, and so drew other gifts. Eventually the class could send Dollars 25m to New Haven.**

All of which tells us three things. The first is that Mr Bush is wasting his political capital if he spends it on charity breaks. The second is that it will not necessarily hurt charity to do away with the estate tax - another issue on the table. To be sure, people do avoid that tax when they give away their fortunes but the specific tax situation matters less than one might think.

"Many people give because they really want to give back," said Ms Christerson of Deutsche Bank. "They say: 'Brooklyn College really mattered to me so I want to endow a chair'." As the number of wealthy households increases, more parents write cheques to charities because they fear creating for their offspring the family version of a welfare state.

The third lesson is hardly new but worth recalling. It is that the law of compounding does not get suspended just because the money involved is "for society". High taxes can be socially inefficient. Greater parsimony and lower tax rates tend to ensure maximum charitable giving in future.

An important message but one that is hard to remember when your brain is shouting: serve now, give now.

*Giving USA, American Association of Fundraising Counsel

**Catalogue for Philanthropy

© Copyright 2004 Financial Times

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