The wealth tax proposals by some major Democratic party Presidential candidates initially have received broad bipartisan polling support and could be in the Democratic party platform adopted in mid-July of 2020.
In this setting, there’s considerable debate about the possible economic consequences of such taxation. One key area of that debate is the potential reaction of philanthropy to a new wealth tax. Would a wealth tax diminish philanthropic contributions by diminishing wealth? Or would it raise contributions as a strategy to avoid or minimize the wealth tax? Also, would income inequality be much reduced if wealth taxation eventually significantly trimmed philanthropic contributions?
What’s being proposed?
During the first months of the Democratic Presidential race, the most prominent wealth tax proposal has been by Massachusetts Senator Elizabeth Warren. She initially proposed a 2% annual tax on Americans with assets above $50 million and a 3% annual tax on people with more than $1 billion in assets. However, as critics claimed that her expensive universal Medicare proposal would significantly boost future Federal deficits, she doubled the proposed annual “billionaire” tax rate to 6%. Also, Senator Bernie Sanders has proposed a graduated wealth tax ranging from 1% on wealth over $32 million to 8% on wealth over $10 billion. (Note: Some of the other leading Democrat contenders have opposed these wealth tax proposals and instead support more taxation of relatively high incomes.) The Warren and Sanders wealth tax proposals at the start of 2020 already had become larger than the initial Warren proposal. This is a reminder that tax proposals initially marketed as only for the very wealthy can become more broad-based in order to fund accompanying promised higher Federal outlays. And as the threshold level of wealth above which the tax kicks in is lowered, there likely would be more of an eventual negative impact on charitable giving.
Why was there initially broad-based voter support?
When questioned about the initial Warren proposal in a February 1-2, 2019 Hill-HarrisX online poll of 1,001 registered voters, 74% supported that proposal. Not surprisingly, 86% of Democrats were in favor of Warren’s plan. Among Independents, 69% expressed support. However, it was surprising that 65% of Republicans supported it.
Also, according to the Q4(19) CNBC Millionaire survey, even a majority (59%) of millionaires were in favor of the Warren wealth tax!. A full 88% of Democrat millionaires supported it, and even a third of Republican millionaires expressed support. The higher 65% fraction of all Republican voters supporting the Warren proposal in the earlier Hill-HarrisX poll must have represented less affluent Republicans.
The reasonably broad-based support of the initial Warren wealth tax planl likely reflects most taxpayers’ support for higher taxes if they are not personally affected. The initial Warren proposal was estimated by Warren’s campaign to raise around $200 billion annually and only affect around 75,000 families–a tiny fraction of the around 123 million US households as of Q3(19). And $28 billion of that $200 billion was claimed to be owed by the richest 15 families, while the richest 400 families would pay $82 billion.
Considering the apparent popularity of a wealth tax, it would seem to stand a good chance of being enacted IF the Democrats in the 2020 election win the White House and both houses of Congress. Also, with reported Republican voters’ support of a wealth tax, it is not inconceivable that at some point in time even a Republican President might support some form of wealth tax if Republican politicians felt compelled to trim likely high Federal budget deficits in coming years.
Would philanthropy rise if a wealth tax was enacted?
Some economists believe a wealth tax actually would stimulate wealthy families’ spending, including charitable contributions, as the rich sought to avoid the tax by spending and thereby keeping wealth below the threshold above which the wealth tax kicks in. (For a representative presentation of this viewpoint, see the October 19, 2019 article by the Tax Policy Center’s Howard Gleckman and titled “A Wealth Tax Will Encourage More Spending By The Rich–Any Maybe More Political Contributions”.) And the most tax-advantaged type of such incremental spending would be tax deductible charitable contributions.
However, there likely are practical limits to wealthy families’ incremental spending and donating in order to avoid a wealth tax. There would be an understandable reluctance to “give it away” rather than pay the wealth tax. Financial wealth is accumulated for a variety of possible future purposes such as taking advantage of evolving investment opportunities, precautionary savings and enhancing heirs’ inheritance. In addition, annual charitable deductions currently are limited to 60% of annual adjusted gross income. That would limit how much very wealthy families would want to incrementally contribute in any given year.
Or would a wealth tax eventually reduce charitable giving?
An alternative viewpoint is that a wealth tax erodes wealth and thus would eventually lead to lesser charitable contributions by the very wealthy. When assessing impacts of wealth taxation on charitable contributions, it’s likely that the cumulative taxes collected over a number of years would eventually have an increasingly negative impact on charitable contributions. An initial 2% per annum wealth tax may not initially reduce wealth enough to make an immediate difference on annual charitable giving. However, the effect of a 2% per annum wealth tax after five years would cumulatively reduce wealth by 10% from what it would have been without the taxation. That could make more of a difference on annual giving levels than initial negative effects. This potential negative impact would be amplified if the wealth tax is applied to private foundations, which has been suggested by some wealth tax advocates. They aim to prevent the wealthy from escaping the wealth tax by putting their wealth in private foundations. (For a representative presentation of this viewpoint, see the October 23, 2019 article by Andrew Wilford of the National Taxpayers Union and titled “Sanders’ Wealth Tax Proposal Would Wreak Havoc on Charitable Foundations”.
How much might wealth be reduced by a wealth tax?
Economists have been sharply divided about how much annual Federal tax revenue would be raised by the initial Warren proposal. Economists working with Elizabeth Warren estimated around $200 billion per annum in annual tax revenues. However, Harvard economist Larry Summers has argued that the tax take could be as low as $25 billion to $75 billion. In Summers’ view, there would be widespread avoidance by the very wealthy who could afford clever tax advice about loopholes, valuation schemes, trusts and other possible structures. To support his claims. Summers used past studies of estate tax avoidance. And economists supporting Summers’ conclusion cite far fewer OECD countries currently relying on a wealth tax because it’s so hard to collect. For instance, Daniel Bunn of the Tax Foundation reports that “the number of current OECD members that have collected revenues from net wealth taxes grew from nine in 1965 to a peak of fourteen in 1996 before declining to just four in 2017.”
Key issue: How would the very wealthy behave?
In assessing possible charitable giving impacts of wealth taxes, it’s important to focus on the behavior of the very wealthy families that are a tiny fraction of the population. The behavior of extremely wealthy families worth upward of $100 million dollars in response a wealth tax could be noticeably different from the behavior of a family whose wealth is not far over a wealth tax threshold. For instance, giving a few million dollars more to charities to escape a wealth tax would seem to be dissimilar to a decision on contributing a few hundred million dollars extra to escape the tax.
And the very wealthy play a key role in philanthropy. According to the Philanthropy Roundtable, the top 1% of the income distribution accounted for around a third of all charitable giving in 2015. Moreover, the top 1.4% of the income distribution made 84% of the volume of charitable bequests. According to Giving USA, in 2017-the latest year for which such data currently are available–total charitable giving from individuals, estates, foundations and corporations reached an estimated $410 billion. Almost $300 billion of that total represented contributions by private individuals. These data suggest that the top 1% of the income distribution contributed $100 billion. In addition, around $33 billion of the almost $40 billion in bequests from estates reflected gifting by the top 1.4% of the income distribution.
How much of that $133 billion be reduced if there’s a wealth tax? The answer depends on how much of the tax is collected and how much would higher tax payments divert funds from charitable giving.
Some lessons from stock market-charity research
One way to address the behavioral question is to review past research on the effects of stock market wealth changes on overall charitable contributions. One such analysis for the 1968-2007 period by John List and Yana Preysakhovich titled “Charitable donations are more responsive to stock market booms than busts” was published in 2010. To be sure, changes in stock market wealth are not necessarily analogous to changes in wealth due to a wealth tax. Nevertheless, there are some possible implications about how charitable contributions might respond to wealth taxation. Specifically, the asymmetric response of charitable contributions to stock market wealth changes is a reminder that when wealth declines the pass through to lower charitable giving is limited by other personal financial and altruistic considerations affecting giving.
Spending choices and wealth taxation
From a behavioral perspective, if a wealth tax does reduce wealthy families’ wealth, they can respond by cutting personal consumption expenditures, investments and/or charitable contributions. For the very wealthy in the top few percent of the wealth distribution, they are unlikely to cut their personal consumption that is probably much lower than their incomes. Economists at the Federal Reserve Bank of Boston recently have estimated that the average propensity to consume (APC) of the top fifth of the income distribution in 2013 was 0.475 versus a 0.974 estimate for the bottom fifth of the income distribution. (See the February 2019 Working Paper by Fisher, Johnson, Smeeding and Thompson titled “Estimating the Marginal Propensity to Consume Using the Distributions of Income, Consumption and Wealth”. Note: The wealthy’s marginal propensity to consume should be a good deal under the reported average propensity to consume.) Moreover, for families in in top few percent of the wealth distribution, the APC probably is much lower than the estimated 0.475 for the top fifth of the income distribution.
If the wealthy do not cut their personal consumption expenditures when their wealth decreases after a wealth tax, they can cut investments and/or charitable contributions. And an argument can be made that the wealthy are more apt to trim investments rather than charitable contributions if a wealth tax reduces their wealth. Why? There’s likely more status in maintaining often publicly visible charitable contributions than in reducing their private annual investments.
Might attempts to reduce taxable wealth before the tax is enacted actually lead to a short run spurt in charitable giving?
That could be the case for the wealthy attempting to reduce their wealth below the threshold levels above which the tax would kick in. However, limits on the income tax deductibility of annual charitable contributions to 60% of adjusted gross income would limit how far the wealthy might accelerate annual giving in anticipation of a wealth tax.
Uncertainty to initially condition wealth tax avoidance strategies
If after the fall elections it appears that a wealth tax is a realistic responsibility, there will be some uncertainties that could limit immediate implementation of wealth tax avoidance strategies. The details of the eventual legislation (e.g., possible wealth tax coverage of private charitable foundations) will be unknown. Another complication is whether the wealth tax will be retroactive. A further uncertainty would be whether a legislated tax eventually would be declared unconstitutional, which has been suggested by some constitutional scholars.
Would wealth taxation do much to reduce income inequality?
Proponents of wealth taxation emphasize it as reducing the growing inequality of incomes and wealth in the U.S. However, accomplishing that objective depends on the amount of wealth tax revenues and how the Federal government spends them. They might be directed to higher transfer payments or lower taxes for the lowest echelons of the income distribution. However, the incomes and standard of living for these beneficiaries could be adversely affected if less charitable giving reduces private funds specifically directed to the poor. (In 2017 around $50 billion of overall private contributions were in the human services category, which includes services for the poor.) In addition, if less private giving reduces the $38 billion of healthcare funding in 2017, the Federal government might need to raise public healthcare expenditures, which could limit funds available for direct income redistribution. Also, if less investment by the wealthy spells considerably less capital formation, there eventually could be an accompanying reduction in the productivity growth required for higher real wages and related living standards.
Conclusions: While some Democratic Presidential candidates’ recently proposed wealth taxes would hit relatively wealthy philanthropists, its potential negative impact on charitable giving probably would be initially limited. First, many wealthy individuals likely will find ways to avoid the tax. Second, reduced growth of very wealthy families’ wealth should not much initially impact their charitable giving. Instead, they probably would reduce their annual incremental investment levels. However, with the passage of time the cumulative negative effects of annual wealth taxation on the level of wealth could start to have more deleterious effects on annual giving levels. In addition, there probably would be more marked negative impacts on charitable giving if the wealth tax threshold levels were to be much lower than are currently being considered by some leading Democratic Presidential contenders. Finally, if wealth taxes were to materially reduce charitable giving, there likely would be more limited net incremental benefits for lower-income families.