06 February 2017

ACR Blog: Money spent by charities is not taxpayer money

by Sean Parnell, vice president of public policy, The Philanthropy Roundtable

Ellen Aprill raised several thoughtful concerns in a recent Washington Post op-ed about proposals to repeal the so-called “Johnson Amendment,” which prohibits 501(c)3 charities including churches from engaging in any partisan political activity (“Trump wants to force you — the taxpayer — to pay for campaigning from the pulpit,” February 3). Unfortunately she also repeats (more than once) a common misconception about the tax exemption for nonprofit organizations, namely that money flowing into charities is taxpayer money because it is tax deductible.

Current law already permits religious leaders and religious organizations to express their views about candidates without undermining our campaign finance laws. What they can’t do is express those views on the taxpayer’s dime…

If an organization, such as a house of worship, accepts favorable tax treatment, they’re being underwritten by the taxes you and I pay. Which is fair enough, but then we, the taxpayers, shouldn’t have to pay for their partisan political speech that we may not agree with…

But money spent by charities, including houses of worship, is not taxpayer money. To understand why, it’s important to understand how the tax code handles contributions to charity.

The two types of deductibility that apply to 501(c)3 organizations are very different – the first allows a donor to deduct the amount given, not from their taxes, but from their taxable income, while the second applies to the organization and prevents the corporate income tax from being levied against them.

Not taxing charitable organizations is easy to understand – as nonprofit corporations they do not, by definition, have profits to tax. Often they do have surpluses, but it’s not difficult to understand why it would be a bad idea to force them to eliminate their reserves at the end of each year, or spend down money raised in one year to fund the next year’s operations.

The exemption from taxable income is different, however. It is true that money contributed to a charity will, in most cases, not be taxed. But this doesn’t transform funds deducted from taxable income into taxpayer dollars subsidizing the charity. Instead it reflects an acknowledgement that the charitable sector lies to a large degree outside of the tax system’s proper jurisdiction, and that money contributed to support charity isn’t properly classified as income.

Consider the following, from a paper by the late Adam Yarmolinsky, a professor of public policy:

If the charitable exemption is not a subsidy, what is it? A more reasonable view might suggest that it marks one of the outer limits of tax policy. Oliver Wendell Holmes acknowledges the existence of constitutional limits on the taxing power in a famous dictum, when he wrote (in dissent at the time), “The power to tax is not the power to destroy, while this court sits,” although he chose not to invoke those limits in that case (Panhandle Oil Co. v. Mississippi, 1928, pp. 218, 223). There have been sharp disagreements in the evolution of federal tax policy over what constituted confiscatory taxation. It took a constitutional amendment to validate the federal income tax, despite Holmes’s opinion that an amendment was unnecessary. However, there seems to be general agreement that the power to tax is not unlimited. This is not to suggest that the charitable exemption has some constitutional protection. Theoretically, the Congress could abolish it. Politically, abolition is a nonstarter. Not Wall Street but Main Street would rise in revolt, because Main Street is the principal locus of the American charitable community.

It seems more consistent with the nature of the American polity, therefore, to think of the charitable deduction as a self-imposed limitation on taxing power, adopted by the Congress on the premise that it is more nearly in accord with the American character to leave to individual discretion some decisions about the allocation of resources for public purposes, where the individual is willing to forgo a portion of his or her personal resources for the same purpose. It does not vitiate this argument that Congress has defined public purposes, in the broadest possible terms, to give scope to individual taxpayer decision making (essentially, charitable, educational, and scientific, along with something called “testing for public safety”), and that it has placed an upper limit on the proportion of one’s resources that can be so used.

An interesting alternative argument was advanced by Andrews (1972) in the Harvard Law Review more than a generation ago. To summarize an extended and highly sophisticated exposition: Because the ideal form of taxation would tax income only when used for personal consumption and accumulation, and because charitable contributions are not available to the taxpayer for consumption or accumulation, the contribution should be tax exempt.

Writing in Philanthropy magazine, tax attorney (and Alliance for Charitable Reform advisory council member) notes that the charitable tax deduction serves the purposes of accurately measuring income and fencing off the nonprofit sector from government interference:

Policymakers sometimes justify these changes by claiming that the charitable deduction is a government subsidy for charity. A more accurate understanding is that the charitable deduction is simply an accounting mechanism to ensure that your income is measured accurately. Money you give away for public benefit is neither part of your income nor the government’s money to claim. Any income tax requires a charitable deduction as a matter of ­principle, because funds given away for the public good are not part of a taxpayer’s personal resources.

The state doesn’t sponsor and subsidize civil society using tax revenue. It is individuals who create civil society using their own funds. The state simply avoids interfering when it eschews taxing of those transactions.

A 2001 paper by Edward Zelinsky, a law professor, further explains why the term “subsidy” is inappropriate when discussing the charitable deduction, at least as it concerns religious entities. After extensive analysis, he concludes:

Today, the Supreme Court’s case law generally conditions tax exemptions, deductions, and exclusions for religious institutions upon the concurrent extension of such benefits to secular entities and activities. The Court’s position flows logically from its acceptance of the premise that tax exemptions, deductions, and exclusions constitute subsidies.

However, as a normative matter, my conclusion is to the contrary. In the context of tax benefits, the “subsidy” label is usually deployed in a conclusory and unconvincing fashion. The First Amendment is best understood as permitting governments to refrain from taxation to accommodate the autonomy of religious actors and activities; hence, tax benefits extended solely to sectarian institutions should pass constitutional muster as recognition of that autonomy. Since it is most compelling to conceive of religious tax exemption as the acknowledgment of sectarian sovereignty, rather than the subsidization of religion, there is no convincing constitutional reason to link that exemption to the simultaneous extension of comparable tax benefits to secular entities and undertakings.

In the final analysis, tax exemption does not subsidize churches, but leaves them alone.

There are good arguments on both sides of the question over repeal of the Johnson Amendment. But the argument that it would mean taxpayer dollars being used for partisan political purposes probably isn’t among them, given its reliance on the dubious claim that the charitable deduction amounts to a subsidy and is equivalent to spending taxpayer dollars.