Critics of Obama Tax Subsidy Proposal Miss Key Points

Some charities and state and local governments have raised concerns about the President’s proposal to cap, at 28 cents on the dollar, the tax subsidy that affluent Americans receive for tax deductions and some other tax expenditures.  Charities worry that charitable donations would drop substantially (although the Tax Policy Center estimates that the decline would be modest); while states and localities worry they would have to pay higher interest rates on their bonds in order to attract investors.  Several important facts are often missing, however, from the discussion of these issues.

• At 28 percent, the top subsidy rate would be the same as during the Reagan years. Some critics of the Obama proposal have noted that under President Reagan, the top marginal tax rate and the top subsidy rate for deductions were both 28 percent, whereas the Obama proposal would create a gap between the top marginal tax rate (39.6 percent) and the top subsidy rate (28 percent).  That’s true but has no bearing on the issue at hand — namely, the effect on charitable giving.  The subsidy rate is what matters here, because it determines filers’ financial incentive to engage in a subsidized activity such as giving to charity or buying municipal bonds.

• The House-passed Ryan budget and House Ways and Means Chairman Dave Camp’s tax-reform process aim to cut the tax subsidy rate below the Obama level. The Ryan budget and Chairman Camp have set a goal of cutting the top marginal rate to 25 percent.  That would put the top subsidy rate for charitable donations and municipal bond interest three percentage points below the Obama cap.

  Most charities and organizations that have criticized the Obama 28 percent limit have been silent about the Ryan and Camp proposals (in many cases, they also were silent during the Reagan and George H.W. Bush years, when the top marginal tax rate was 28 percent).  Some may mistakenly assume that what counts is the difference between the marginal rate and the subsidy rate — when, in fact, it is the subsidy rate that matters.

• The Obama budget would use the resulting savings primarily to replace the sequestration budget cuts, thereby helping both charities and states and localities. Sequestration is scheduled to impose even deeper cuts next year and to remain in effect through 2021.  Its harsh cuts in a range of programs — including those that alleviate poverty or combat disease at home or abroad as well as programs in education, environmental protection, health research, the arts, and many other areas — will place heavy added burdens on both charities and state and local governments.

  Many nonprofits receive grants or contracts to provide services that are funded in part or in whole through federal programs, especially non-defense discretionary programs that operate through state or local governments.  Meanwhile, most federal grants that state and local governments receive to help them perform various functions come through programs subject to sequestration.

  In fact, sequestration will impose a double burden on nonprofits, raising the demand for their services while slicing their revenues.

  Thus, cancelling sequestration is of considerable importance to the charitable sector and to state and local governments.  While charities and state and local governments would lose some revenue from the proposed 28 percent limitation on tax deductions and exclusions, they would receive substantial revenue gains from repealing sequestration.

  By contrast, under the Ryan and Camp proposals, not only would charities and state and local governments suffer bigger losses from those plans’ reductions in tax subsidy rates, but none of the resulting revenue would go to ease sequestration or other budget cuts.

  Moreover, if all of the revenue from scaling back tax subsidies goes to lowering tax rates, as the Ryan budget and Chairman Camp propose, then further deficit reduction will likely come entirely from the spending side of the budget.  (In addition, it’s very unlikely Congress would be able to pass enough tax-expenditure savings to pay for lowering the top rate to 25 percent; if the resulting tax reform lost revenue, the ensuing budget cuts would likely be bigger still.)

  In short, additional cuts — on top of sequestration — in areas such as education, low-income programs, and state and local aid would almost certainly result from the Ryan-Camp approach, making the job of charities and state and local governments even more difficult.

Some critics of the Obama 28 percent limit say there are other ways to raise revenues for the purposes that the President has proposed.  But in most cases, they haven’t offered specific alternatives or they have suggested alternatives that, despite their merits, have little or no political viability in the current political environment.

The task remains of raising revenues to replace sequestration and to serve as part of a balanced long-term deficit reduction package, and the 28 percent limit remains the most promising proposal that is not significantly beyond the bounds of current political reality.