The Next Step Toward Welfare Reform:

A Manual for Enacting Tax Credits

for Charitable Contributions

March 1998

The Beacon Hill Institute for Public Policy Research focuses on federal, state and local economic policies as they affect Massachusetts citizens and businesses. The institute conducts research and educational programs to provide timely, concise and readable analyses that help voters, policy makers and opinion leaders understand today's leading public policy issues.

© March 1998 Beacon Hill Institute at Suffolk University

ISBN 1-886320-04-7

Contents

1. Introduction

The passage of the Personal Responsibility and Work Opportunity Act of 1996 presents an opportunity to devolve power from Washington and to test the belief that innovation can flourish best at the state level. As laboratories of democracy, the states can take the next step toward welfare reform by establishing state tax credits for charitable contributions.

Encouraged by charitable tax credits, taxpayers can donate money directly to a food pantry, homeless shelter or private job-training program. They can have a voice in how their money will be used to assist the poor.

The advantages are numerous. Instead of "paying" the government to provide welfare benefits, with the money filtering down through the system, taxpayers provide direct assistance themselves. This privatization of the welfare delivery system enhances demand for talented, innovative organizations that can help people become self-sufficient. It encourages taxpayer participation, through voluntarism and oversight, in the delivery of welfare services.

In effect, a market system for private human-services emerges. As revenues from the tax credit grow, more nonprofits enter the field. Accountability and competition improve efficiency. Nonprofit organizations that underperform lose the support of taxpayers while those fulfilling their mission flourish. Moreover the poor themselves can choose which programs best suit their needs.

The Next Step Toward Welfare Reform: A Manual for Enacting State Based Charitable Tax Credits is a working guide for legislators, policymakers and opinion leaders interested in the implementation of charitable tax credits in their states. It provides answers to the theoretical and operational questions that arise when introducing tax credit legislation. It also includes model legislation that provides a starting point for states considering the adoption of a charitable tax credit.

While many Americans support welfare reform in its current form, they also support greater taxpayer involvement. In the fall of 1996, the Beacon Hill Institute asked 250 nonprofit executives in six states what they thought about tax credits. They registered strong support: 88% were in favor of tax credits for charitable contributions.

In the fall of 1997, BHI conducted a survey in which they asked Massachusetts residents if they would favor a proposal that gives taxpayers the right to deduct $200 from their state taxes if they give the same amount to a private charity that helps the poor. A resounding 81% favored the idea.

In January 1998, we asked a complementary question: If the government cut back on welfare spending, would you be more inclined to give to charities that helped the poor? By a margin of 59% to 29%, Massachusetts residents said they would be inclined to give more.

Beyond the considerations of public opinion, however, lie several new state based tax credit programs. They are examined in detail in section 5 of this manual. The framework for predicting giving in section 7 provides a methodology for determining the effects of a charitable tax credit on contributions and on tax revenues.

In order to write effective tax credit legislation, state legislators and policymakers must evaluate a host of preliminary considerations unique to their respective states. These include the philosophical and political consensus around the issue of welfare reform; the degree of administrative or bureaucratic inefficiencies within the current delivery system; the current role of nonprofits that provide human services and their prospective roles in a new competitive system; and how a charitable tax credit program could operate under the new federal Temporary Assistance to Needy Families (TANF) program.

For further information or to review other Beacon Hill Institute materials on charitable tax credits, we invite you to visit the Beacon Hill Institute's Center for Alternative Welfare Reform on our web site: www.beaconhill.org.

2. Implications for Taxpayers and Donors

2.1. What is the difference between a deduction and a tax credit for charitable giving?

Most taxpayers are familiar with tax deductions. Federal tax law encourages giving by offering deductions. Federal taxpayers who itemize can take tax deductions for the amount they contribute to eligible charities. This permits them to reduce their taxable income by what they contribute to these charities. Thus, for example, an itemizing federal taxpayer who is in the 28% bracket can reduce his taxable income by $100 and his tax bill by $28 by contributing $100.

A tax credit, on the other hand, permits the taxpayer to reduce his tax bill by some fraction of what he contributes. Thus, for example, a 50% tax credit permits the taxpayer who contributes $100 to reduce his tax bill by $50.

2.2. Is the charitable tax credit compatible with a flat tax?

Some proponents of the flat tax believe that a charitable tax credit is not compatible with a flat tax. The purpose of the flat tax, they argue, is to simplify the tax code, and a charitable tax credit adds unwanted complexity. While simplicity is a worthy goal, there are other goals that make the two ideas compatible.

How can the argument for a charitable tax credit be reconciled with that for a flat tax? The answer depends in part on the goals of each. Generally, the goals of a flat tax are threefold: (1) to simplify reporting and collection, (2) to flatten the rate structure and (3) to eliminate the double-tax feature of the existing tax system. All three goals are intended to advance the broader goal of increased economic efficiency and growth.

Generally, the goals of the charitable tax credit are: (1) to shift the delivery of welfare benefits from the public to the private sector, (2) to effect a redistribution of income from the nonpoor to the poor in a fashion superior to the current system and (3) to increase efficiency by empowering both individual donors and nonprofit organizations.

Simplification. Insofar as it eliminates the use of the tax code to provide incentives or disincentives for individuals to engage in certain kinds of economic behavior, the flat tax contributes to simplification. A charitable tax credit would add another line to a streamlined postcard-sized tax form, and, by proliferating “exceptions,” threaten to turn the postcard into another 1040.

However, simplicity should be measured against the expected cost saving that would come from the privatization of welfare through the proposed system of tax credits. If shifting the delivery of welfare benefits from the public to the private sector reduces waste by encouraging voluntarism and by eliminating an unnecessary bureaucratic filter, then a longer tax return is a small price to pay for the greater efficiency achieved.

Flattening the rate structure. The charitable tax credit does not conflict with the goal of a flatter rate structure. Any tax requires the taxpayer to sacrifice a certain portion of each additional dollar of taxable income. If the marginal tax rate is 25%, the sacrifice is 25¢ regardless of income. The difference between a tax code with a charitable tax credit and a tax code without a charitable tax credit is that the former permits the taxpayer to make this sacrifice in part by donating to an eligible charity whereas the latter requires him to make it by paying all 25¢ in taxes.

In order to make this point more clearly, it may be useful to adopt a slight change in terminology. Rather than speaking of a marginal tax rate, perhaps we should speak of a “marginal sacrifice rate.”

Consider a flat tax of 30% with a personal exemption of $10,000. Taxpayers A and B each have a gross income of $50,000 and thus a taxable income of $40,000. Now suppose that taxpayers may take a 100% tax credit for contributing to organizations that help the poor. Taxpayer A makes eligible donations of $5,000, while taxpayer B makes no donations. Both make a “sacrifice” of $12,000 (= .30•$40,000), and both have a “marginal sacrifice rate” of 30¢ on each dollar earned over $10,000. The only difference is that taxpayer A makes his sacrifice by donating $5,000 to charity and $7,000 to government, whereas taxpayer B makes his entire sacrifice by paying $12,000 to government.

In this example, the institution of the flat rate imposes the same marginal sacrifice rate on all taxpayers irrespective of whether they give to eligible charities or not. There is no substantive difference, therefore, between a flat tax with a charitable tax credit and a flat tax without a charitable tax credit.

Elimination of the Double Tax. The existing tax system taxes certain income twice, once when it is earned as wages and again when it is earned as income on saving. Suppose taxpayers A and B receive $40,000 in wages in 1998 and pay a tax of 25% on this amount. Each has an after-tax income of $30,000.

Now suppose that taxpayer A spends all of his 1998 after-tax income on consumption but that taxpayer B allocates $10,000 of his after-tax income to saving. Then taxpayer A pays no additional tax as a result of economic decisions made in 1998. Taxpayer B, on the other hand, pays future taxes on income received on his 1998 saving. If, for example, taxpayer B bought a $10,000 bond yielding interest of 10%, he pays an additional tax of $250 each year over the life of the bond.

One way to eliminate this double tax is to exempt the return of interest on the bond from taxation. Another way is to exempt the purchase of the bond (saving) from taxation. In either event, the tax is paid only once. The tax falls on income only when it is consumed.

An income tax that defines taxable income as consumption is equivalent, in terms of the sacrifice it imposes, to a retail sales or value-added tax. The difference is that an income tax makes it administratively easier to allow the taxpayer to make part of his sacrifice by donating to eligible charities or to other causes that might otherwise fall to government to support.

A flat tax achieves simplification and flatness and increases economic efficiency by defining taxable income as consumption. Suppose that taxable income so defined is $40,000 and that the tax rate is 25%. The tax liability before any charitable tax credit is $10,000. If the taxpayer gives $1,000 to eligible charities, the charitable tax credit permits him to reduce his tax liability to $9,000 (making the rest of his sacrifice through donations to eligible charities). No part of the sacrifice made by the taxpayer falls on saving. The charitable tax credit does not conflict in any way with the principle that taxable income should be defined as consumption.

It should be noted, finally, that every practical flat-tax proposal permits the taxpayer to take a large personal exemption. The purpose of this exemption is much the same as that of government welfare spending: to effect a redistribution of income from the nonpoor to the poor. Insofar as a charitable tax credit represents a superior way of carrying out this redistribution, then it is compatible with the idea of a flat tax. Indeed, it reduces the required size of the personal exemption.

2.3. How would the tax credit impact the current level of giving? Would taxpayers give more or not?

The tax credit would increase the current level of giving. In fact, some limit on the credit would be necessary to prevent too great a loss of tax revenues. In section 7, we estimate both the price and income “elasticities” of giving, where the price elasticity is the percentage change in giving that results from a 1% change in price and the income elasticity is the percentage change in giving that results from a 1% change in income.

Our results suggests that individuals give more to charity as the “tax price” of giving (the before-tax price less tax saving) decreases. Suppose that there is no tax incentive to give. Then the before-tax price of giving a dollar is the same as the after-tax price – $1. If Smith gives a dollar it costs him a dollar. Now suppose that Smith can take a 50% tax credit for giving. Then the after-tax price falls by 50%. If Smith gives a dollar it costs him 50¢.

BHI research shows that people give more as the tax price of giving falls. The “elasticity” of giving with respect to tax price is about 1.12, which means that a 10% reduction in the tax price of giving causes giving to rise by 11.20%. It also shows that people give more as their incomes increase, with a 10% increase in income leading to a 3.5% increase in contributions.

The exact impact depends on the size of the tax credit and on the limit placed on the tax credit. BHI has developed a model to predict eligible giving under different tax credit scenarios. In section 7, we estimate giving for two states, Oklahoma and Massachusetts, under a 50% tax credit, with no limits. Our model shows that Oklahoma taxpayers would increase eligible giving by $90 million, from $70 million to $160 million. Eligible giving by Massachusetts taxpayers would increase by $167 million, from $143 million to $310 million.

2.4. What do taxpayers think of tax credits?

According to BHI survey research, the idea of tax credits for charitable contributions draws support from every demographic category including ethnic background, political party affiliation, age, income, educational attainment and gender. See Appendix I.

In the fall of 1997, BHI, with the cooperation of Commonwealth Consulting and Clark University, asked Massachusetts residents if they would “favor or oppose a proposal that gives taxpayers the right to deduct $200 from their state taxes if they gave the same amount up to $200 to a private charity that helps the poor?” A resounding 81% favored the idea while 14% opposed. Eighty percent (80%) of those with incomes under $30,000 supported the proposal; while 87% of those with incomes over $50,000 expressed support. See Question 1 in Appendix I.

In January 1998, we asked two complementary questions. First we asked: “Would you be more inclined to give to charities that help the poor if you got a more generous tax break for giving?” Sixty-nine percent (69%) said they would be more inclined while 25% said they would not be inclined. Support among those earning between $15,000 and $30,000 (69%) was as strong as among those earning between $50,000 and $75,000 (68%).

In addition, we asked: “If the government cut back on welfare spending, would you be more inclined to give to charities that helped the poor?” Voters by a margin of 59% to 29% said they would be inclined to give more. Those with lower incomes were particularly responsive. Persons on the lower income scale (income between $15,000 and $30,000) were more likely to give (74%) than those with incomes between $30,000 and $50,000 (56%) and those with incomes over $100,000 (51%).

These results underscore a willingness by the public to provide private funds to help the poor if the cost of giving decreases. They also counter, in part, the criticism that the private sector is incapable of meeting the needs of the poor in light of welfare reform.

With regard to tax credits, taxpayers are joined in their support by providers of services to the poor: the individuals who manage local nonprofit organizations. In the fall of 1996, BHI asked 250 nonprofit executives in six states what they thought about tax credits. They registered strong support: 87% voiced their support while only 13% opposed or did not know. See Appendix II.

Our polls show that taxpayers strongly support giving to local, community-based organizations. In January 1998, we asked: “If you were to donate $100 to help the poor, to which one of the following would you be most likely to give all the money?: Catholic Charities, The Salvation Army, Habitat for Humanity, or a local food pantry or homeless shelter?” A plurality of respondents chose food pantries or local shelters.

2.5. Which taxpayers will be eligible to claim the credit?

1. The goal of encouraging individual oversight of and participation in the work of eligible private charities argues for limiting the credit to individual taxpayers. By this logic, contributions by pass-through business entities, such as S-corporations, partnerships and limited liability companies should qualify for a credit, whereas C-corporations should not. Individuals who do not itemize their deductions in states where deductions are allowed (i.e., individuals who take the standard deduction and receive no tax benefit from contributions) should be eligible for the credit. These taxpayers are an important source of donations and potential volunteers. In section 7, we estimate giving under a tax credit in Oklahoma and in Massachusetts for both itemizers and nonitemizers.
2. A state's decision to include corporations would depend largely on whether or not personal income is taxed. Allowing corporations to participate in the tax credit could be viewed by taxpayers as a giveaway to big businesses. Inclusion of corporations in a tax credit program, however, would offer states the opportunity to privatize a larger share of their welfare system. A tax credit for corporate giving may be indicated in states that do not have an income tax.

2.6. What types of contributions qualify for the credit?

Options available to legislators and policymakers include cash, in-kind and appreciated property. Most proposals, however, restrict qualification for the credit to cash contributions. Some proposals do allow for in-kind contributions, either to nonprofit organizations or directly to the poor. BHI recommends restricting contributions to cash contributions.

BHI recommends against appreciated property because it would allow the taxpayer, in substance if not in form, to “sell” the asset to the charity without recognizing a capital gain. This practice would result in massive revenue losses, since taxpayers could give all their appreciated assets to qualified charities rather than selling them. The motivation to give to charity would be pure tax avoidance, rather than altruism. A gift of stock worth $1,000, for example, with a cost basis of $300, would yield a deduction of $1,000, and the state would never see the tax revenue that the $700 of appreciation would have yielded.

2.7. Should taxpayers be allowed to take both the deduction and the credit?

1. BHI recommends that states not allow taxpayers both a deduction and a credit. This is because under certain conditions, a deduction and a credit could result in a positive cash flow for taxpayers.
2. For example, Oklahoma allows deductions for charitable contributions. As we said in 2.1 above, a tax deduction reduces an individual's tax liability by lowering his taxable income. Assume that Oklahoma institutes a 100% tax credit for charitable contributions, reducing the price of giving to zero. The average state marginal income tax rate on personal income is 6.3%. When taxpayers combine the tax credit and the tax deduction, they end up with a bonus: a positive cash flow of approximately $.05 for every dollar they donate. The price of giving one dollar under a tax deduction and tax credit is: P₁ = 1 - t_f - (t_s)(d_s) + (t_f)(t_s)(d_s) - t_c + (t_f)(t_c). P₁ = .05 = 1 - .230 - .063 + .0145 - 1 + .230. See section 7 for a detailed explanation on the price of giving.

2.8. What fraction of giving should count as a credit?

A charitable tax credit increases giving by reducing the tax price of giving. Is it appropriate to reduce that price to zero by offering a 100% tax credit, or is there an argument for a more limited reduction in tax price to, say, 50¢? The argument for a more limited credit stems from the assumption that, unless taxpayers must make some additional sacrifice they will not take an interest in how their contributions are used by the charities to which they contribute. When Smith must pay for a cup of coffee, he pays more attention to the quality of the coffee he drinks than he would if coffee were free. The same idea applies, so it might be argued, to charitable giving.

3. Considerations for State Policymakers

3.1. What level of government is most likely to offer a tax credit?

1. A tax credit can be implemented at the federal, state or local level. Devolution argues for implementation at the state level. More than 20 states offer some form of charitable tax credits and several states are considering legislation (see section 5).
2. States can institute statewide or local programs. Local tax credits can be limited to a particular city, metropolitan statistical area or designated region. The geographic area covered by the local tax credit would be based on the size and scope of the program.

3.2. What would a tax credit program mean for current state welfare expenditures?

A charitable tax credit makes it possible to reduce public spending on welfare. A dollar contributed privately makes it possible to reduce by one dollar or more (depending on the cost saving achieved) the amount spent by the public sector on the provision of assistance to the poor.

3.3. What will the credit percentage and limit be?

The size of the credit percentage and the limit of the credit depend on the desired level of welfare privatization. The limit of the credit would also depend on the marital status of filers. States must determine the amount of additional giving they wish to bring about in order to fund privatized welfare programs (and, with that, the amount of revenue they are prepared to forgo) and then develop a tax credit that has the intended result.

The Beacon Hill Institute has observed, however, that taxpayer participation in state tax credit programs tends to be low, at least in the early stages. Legislators must consider this fact when deciding on the amount of giving needed to fund privatized welfare programs. For example, our research shows that between 2% and 6% of taxpayers participate in various state targeted tax credit programs.

1. Additionally, the size of the percentage and the limit of the credit should be set so that the proposals remain revenue neutral. That is, states should reduce spending and revenue by like amounts to avoid deficit spending.

3.4. How will the credit be set?

1. States have two questions to answer in setting the tax credit limit. What fraction (100%, 50%) of a contribution may the taxpayer take as a credit, and what, if any, limit should there be on the amount that may be taken as a credit? The answer depends on the expected response by the taxpayer and on how much of the state's welfare system is to be privatized. In an earlier report, ^[1] we propose a 100% tax credit limited to 25% of federal tax liability. We estimate that this limit would be enough to shift $115 billion of welfare spending (essentially all nonmedicaid federal welfare benefits) from the federal government to private charities. A number of states choose a 50% credit and limit the size of the credit that a taxpayer may take to $100 to $500.
2. Each option has its advantages and disadvantages. Setting the tax credit limit at a fraction of total tax liability permits the amount of giving eligible for the credit to expand with income. This kind of tax credit may be politically unattractive on the ground that it favors the wealthy, who pay more in taxes.
3. Alternatively, setting a tax credit limit at some dollar amount would be seen by many as more equitable. The principal objection to a dollar limit is that it artificially and unnecessarily limits contributions by the very taxpayers – the wealthy – who are most disposed to help the poor.
4. Several states have introduced or considered tax credits with a cap on the dollar amount that can be claimed. Arizona enacted a 100% charitable tax credit allowing taxpayers a maximum credit of $200. At the request of Representative Mark Anderson, BHI submitted a report to Arizona's House of Representatives Committee on Block Grants and Welfare Reform. We recommended a 50% tax credit. ^[2] The Arizona legislature chose the 100% tax credit because they felt that it “enables donors to essentially `give for free' which [they] felt would be easier to administer, and provide more of an incentive to give.” ^[3]
5. In 1997, Oklahoma considered a 15% tax credit with a limit of $200 for charitable contributions to qualifying organizations. In Colorado, a taxpayer who participates in the Enterprise Zone Credits program is allowed a 50% credit, up to a maximum credit of $100,000.

3.5. By what date must a contribution be made in order to claim a credit?

1. States can set the deadline for the end of the tax year or for April 15 of the year following the tax year. The April 15 deadline is consistent with the federal rules regarding individual retirement accounts.

An argument against this deadline is that the credit should be given only to those who are motivated by altruism and not by tax avoidance. Insofar, however, as the purpose of the charitable tax credit is to motivate giving, the later deadline seems appropriate.

3.6. How can state policymakers know if a tax credit program would work in their states?

A state tax credit pilot program for a specific area (county, district or metropolitan area) can assess the viability of the charitable tax credit. It can also provide a laboratory in which to determine how full implementation of the tax credit may affect taxpayers/donors, recipients and nonprofit charitable organizations.

BHI recommends a pilot program that extends over a period of four years. This time frame would give selected nonprofit organizations the opportunity to develop, market and implement the program, with the first year devoted to fundraising by the nonprofit organizations. Implementation would take place during the remaining three years, which would provide sufficient time for participating donors, recipients and nonprofit organizations to demonstrate measurable behavioral changes.

A publicly-funded program is one option for a pilot program. A privately-funded pilot program is a second option. The state would offer recipients a chance to participate in the current public-assistance program or in the privately-funded one.

3.7. How can abuses be prevented under a tax credit program?

Abuses can arise if welfare recipients engage in “double dipping” (accepting benefits from more than one charitable organization), if charities use the additional giving to fatten salaries or otherwise to engage in wasteful spending or if taxpayers set up fictitious charities for the purpose of funneling the funds back to themselves, relatives or friends.

A state welfare department or watchdog organization could discourage double dipping by creating a central registry to track client usage of charities. The state tax department could discourage abuse by nonprofit organizations by hinging their certification on their satisfaction of standards regarding spending on salaries, fund raising and other kinds of overhead. Legislation could be included that would prevent wealthy individuals from passing tax-free dollars to their relatives. For example, a tax credit proposal in North Carolina contains language that prohibits taxpayers from having a financial interest in a nonprofit organization.

States could also require nonprofit organizations to report regularly on finances, programs and client outcomes. From these reports agencies could issue their own reports on how well the nonprofits managed their money and whether they were meeting the needs of recipients. Taxpayers would add another layer of oversight.

3.8. Would taxpayers merely substitute contributions eligible for the credit for ineligible contributions and pocket the savings?

We do not believe that a tax credit would cause measurable substitution of eligible for ineligible contributions. Because the BHI proposal permits charitable contributions ineligible for the new tax credit to qualify for existing tax deductions, it does not affect such tax incentives that already apply to those contributions. Furthermore, there is a “crowd-out” effect, whereby decreased government spending on welfare programs encourages individuals to give more to charities that assist the poor.

Even so, there is a concern that taxpayers would reduce contributions to charities that are not eligible for the credit. This is more likely, the more that an eligible contribution can be seen as a substitute for an ineligible one.

We performed a variety of statistical analyses aimed at testing for this concern. We found evidence arguing against this concern and therefore against the likelihood of substitution: There is strong positive correlation between all types of charitable giving over time, both in nominal and in real dollars. We found giving to religious and human-services organizations to be complementary, i.e. as individuals increase giving to one kind of organization, they will increase giving to the other kind of organizations.

Despite the foregoing assurances, concerns about possible substitution of eligible for ineligible contributions may persist. To answer these concerns, we offer an alternative to our original proposal: The taxpayer could not take a credit for any contribution during the current year unless total contributions exceeded some threshold.

One threshold would hinge eligibility for the tax credit on prior year giving. Eligibility for the credit would be limited to contributions in excess of the prior year's giving. A threshold of this kind would bring about the desired increase in eligible giving while deterring taxpayers from decreasing ineligible giving.

3.9. What is the definition of poor used to set qualifications?

1. One option is to define the poor as a percentage of the federal poverty level, for example, an income below 150% of the federal poverty level for a family of a certain size. Another option defines poor as eligible for AFDC or TANF. A third option is to limit the tax credit to organizations that provide certain goods (cash grants, food, clothing) to the poor.

North Carolina defines recipients of the tax credits as those individuals who do not rise above 150% of the federal poverty line. Arizona defines recipients of tax credits as the “working poor.” The “working poor” is defined as persons who qualify as eligible individuals for purposes of the federal earned income tax credit.

4. Implications for Nonprofit Organizations

4.1. Which types of organizations would qualify for the credit?

1. Ideally, most secular and nonsecular nonprofit organizations that offer services to the poor would qualify for a charitable tax credit program. Specific qualifications would be determined by the welfare service or services that the tax credit would fund in each state. The amount of the welfare system to be privatized would also influence the types of organizations that would qualify.

4.2. What types of services must the organization offer to be eligible?

This depends on the extent of the state's welfare privatization. State legislators and policymakers typically focus on means-tested programs such as food stamps, cash aid, housing and related services. Since many nonprofit organizations already provide these services to the poor, with added financing, they could easily move to an expanded role in the provision of services.

1. Under a fully privatized welfare system, nonprofit charitable organizations would have to offer services that are normally provided by state government. Most nonprofit charitable organizations currently lack the capacity and the resources to operate in a fully privatized welfare system. Given sufficient time, however, nonprofits could effectively and efficiently service recipients in a privatized system.
2. Under a partially privatized welfare system, the state would decide which means-tested welfare programs would be privatized. States that have proposed or enacted a tax credit legislation typically list specific programs that qualified organizations could provide. For example, a charitable tax credit proposal by Rep. David Peters of Massachusetts limits services to the provision of food, shelter, fuel assistance and child care for needy individuals and families. A tax credit proposal in Oklahoma defined assistance to the poor as food, shelter, health care, clothing, housing, job training and substance abuse treatment. In Arizona, the Charitable Tax Credit Act allowssss taxpayers to contribute to any nonprofit organizations offering any assistance to the working poor.

States could require qualifying charitable organizations to offer some or all of the following means-tested programs:

1. clothing;
2. foster-care and guardianship organizations;
3. emergency shelter for psychiatric emergencies;
4. housing and employment for the elderly;
5. employment and job training services, placement and counseling, but not through schools or colleges;
6. public food assistance (food stamps and in kind), food pantries, and soup kitchens;
7. fuel assistance;
8. housing subsidies, housing in kind, and housing counseling and mediation;
9. emergency shelters and emergency housing;
10. cash aid such as AFDC and SSI;
11. child care;
12. alcohol and substance abuse counseling and care;
13. child abuse and neglect; and
14. youth development for the disadvantaged.
15. This list is not intended to be exhaustive, but merely illustrative of the types of services offered by qualified nonprofit organizations.

4.3. Who certifies that the organizations are eligible to receive contributions?

1. The state could delegate the responsibility of certifying nonprofit charitable organizations to a state agency, such as a department of revenue; to a private nonprofit organization, such as the United Way; or to a private nonprofit watchdog organization. States who choose to certify nonprofit charitable organizations themselves could absorb the administrative cost or recoup their cost by charging nonprofit organizations a small registration fee.
2. In practice, states that have proposed or enacted tax credit legislation have chosen either a government agency or a nonprofit organization to certify and oversee qualifying nonprofit charitable organizations. North Carolina's charitable tax credit proposal, for example, would place the responsibility of certifying eligible organizations with the Secretary of Human Resources. Nonprofit organizations seeking to be certified there would pay a $75 application fee. Arizona, on the other hand, has designated the United Way as being responsible for certification.

4.4. Can churches, religious groups or mixed-used organizations qualify to receive eligible contributions?

1. Under most proposals, churches and mixed-use organizations would qualify if they spent a certain percentage of their funds providing services to designated recipients or if they partitioned qualified services from the remainder of their budgets with no cross spending. For example, a tax credit proposal in Oklahoma restricted charitable donations made to churches or charitable organizations to the specific division offering qualified services to the poor.
2. State legislators and religious leaders may worry that church parishioners would substitute giving to the church in exchange for giving to the part of the church that services the poor or receives contributions. States could stipulate that tax credits would be offered only for contributions over and above those made in the previous year. Many parishioners would give to the church as well as to the section of the church that provides services to the poor.

4.5. Is there any limit to the amount a qualified organization can spend on advocacy or legal services, marketing and administrative services?

1. Usually some percentage of funds, for example 70%, must be spent on primary services to recipients. This limit is established to ensure that tax credit dollars are spent directly on recipients, not used for other purposes.
2. In most cases, tax credit legislation limits nonprofit charitable organizations' administrative expenditures to 30% of their total budget. Some legislation and some proposals allow nonprofits to include the salaries of staff members who provide services to the poor in their calculation of the 70% threshold.
3. Some legislation allows nonprofit organizations to dedicate part of their administrative budget for other expenditures. For example, in North Carolina, a tax credit proposal would allow nonprofit organizations to spend part of their administrative budget on advocacy for the poor and on legal services. Oklahoma's tax credit proposal requires that no more than 30% of a nonprofit organization's expenditures be for administrative and fundraising purposes.

4.6. What is the appropriate role of solicitation organizations in delivering welfare benefits?

BHI does not recommend offering credits for donations to solicitation organizations (such as the United Way) because such entities represent an administrative “filter” that absorbs funds better spent directly on the poor. Admittedly, reasonable arguments can be made in support of solicitation organizations, such as those based on economies of scale and better quality control. We believe, however, that organizations would develop their own funding networks and arrangement for quality-control without the need for solicitation intermediaries. The question is, however, open to further research.

5. Current and Proposed State Tax Credit Legislation

5.1. Current Legislation.

• Arizona: Credit for contributions to charities that help the poor.
• California: Enterprise zone contribution credit, vacant building rehabilitation credit.
• Colorado: Enterprise Zone Contribution Credit (EZCC).
• Connecticut: Neighborhood Assistance Credit (NAC).
• Delaware: Neighborhood Assistance Credit (NAC).
• Georgia: Credits for businesses in less developed areas that create new jobs, employers that provide basic skills education, employers that employ AFDC recipients.
• Idaho: Credit for Contribution to Youth and Rehabilitation Facilities (CCYRF).
• Indiana: Neighborhood Assistance Credit (NAC).
• Kansas: AFDC Family Contribution Credit (FCC) and Community Service Contribution Credit (CSCC).
• Michigan: Community Foundations Credit (CFC) and Homeless Shelter/Food Bank Credit (HFC).
• Missouri: Neighborhood Assistance Credit (NAC).
• Montana: Dependent care assistance credit.
• Nebraska: Neighborhood Assistance Credit (NAC).
• Oregon: Child care tax credit, dependent care tax credit, child development program credit.
• Pennsylvania: Neighborhood Assistance Credit (NAC).
• Rhode Island: Enterprise zone credit.
• South Carolina: Credit for charitable organizations that provide child-care services.
• Utah: Rehabilitation Sheltered Workshop tax credit.
• Virginia: Neighborhood Assistance Credit (NAC).
• Wisconsin: Development zone tax credit.

Of particular interest, Michigan allows a 50% tax credit for contributions to community foundations, homeless shelters and food kitchens. Colorado allows a 50% tax credit for contributions to charities within enterprise zones. Idaho allows credits for contributions to its children's homes. Indiana and Missouri have neighborhood assistance programs, and Kansas allows credits for those who support AFDC recipients.

5.2. Proposed Legislation

6. Model Legislation

Depending on the complexities of the proposed legislation, especially concerning welfare, writing legislation can be an arduous and painstaking process. To make the process easier and more efficient, BHI has crafted a generic tax credit model legislation that any state could use as a starting point. This legislation is a product of ongoing cooperation between BHI and the American Legislative Exchange Council's Health and Human Services Task Force, with input from other institutes.

Section 1. Title.

This act may be cited as the Charity Tax Credit Act.

Section 2. Definition

“Eligible individuals” means all taxpayers, both those who itemize and those who do not itemize deductions on their federal tax returns.

“Credit” means an amount equal to the qualified contributions paid by the taxpayer to one or more qualified charities during the taxable year, up to a maximum credit as provided in Section 3.

“Qualified Charity” means a nonprofit organization that meets the following conditions:

1. The organization must qualify for nonprofit status under section 501(c)(3) of the Internal Revenue Code, and must be tax-exempt under section 501(a).
2. Contributions to the organization are deductible as charitable contributions for federal income tax purposes.
3. The organization is certified by the {insert appropriate state department or nonprofit organization} as primarily assisting the poor, as provided in Section 4.

“Qualified Charitable Contribution” means a charitable contribution made in cash to a qualified charity.

Section 3. Charitable Contributions.

1. Eligible individuals can contribute to one or more qualified charities during the taxable year, and will be given a {amount}% credit of the maximum amount of {amount} for single filers and {amount} for joint filers.
2. Contributions must be made in cash.
3. Contributions to be eligible for a tax credit must be made by April 15th of the following year.

Section 4. Tax Credit Carryover.

If the allowable tax credit exceeds the taxes otherwise due on the claimant's income, or if there are no taxes due, the taxpayer may carry the amount of the unused claim to offset the taxes forward for not more than five consecutive taxable years' income tax liability.

Section 5. Contributions to Qualifying Charitable Organizations.

The credit should apply only to contributions to qualifying charitable organizations that exceed the total amount deducted pursuant to Section 170 of the Internal Revenue Code in the taxpayer's baseline year or ${amount}, whichever is greater. The taxpayer's baseline is the 1997 taxable year if the taxpayer deducted charitable contributions pursuant to Section 170 of the Internal Revenue Code in the 1997 taxable year.

Section 6. Eligibility of Qualified Charity.

1. A nonprofit organization must receive certification by the {insert appropriate state department} that its predominant activity is the provision of services to individuals who {definition of poverty}.
2. Organizations and programs that qualify for the tax credit include those providing the following means-tested programs: clothing; foster-care and guardianship organizations; emergency shelter for psychiatric emergencies; housing and employment for the elderly; employment and job training services, placement and counseling, but not schools or colleges; public food assistance (in kind and food stamps), food pantries, and soup kitchens; fuel assistance; housing subsidies, housing in kind, and housing counseling and mediation; emergency shelters and emergency housing; cash aid such as AFDC and SSI; child care; alcohol and substance abuse counseling and care; child abuse and neglect; youth development for the disadvantaged.
3. These services will be the organization's predominant activity and the organization's annual expenditures for providing these services will be at least {amount}% of the organization's annual aggregate expenditures.
4. No more than {amount}% of the organization's overall budget can be used for overhead costs which may include: administrative expenses; expenses primarily for the purpose of fund raising; or expenses for legal services on behalf of the organization.
5. No more than {amount}% of the organization's overall budget may be used to pay for one or more of the following activities: voter registration; political organization, public policy advocacy, public policy research, or other ways of influencing legislation.

Section 7. Certification of Qualified Charity.

1. The certification of an organization is valid for the calendar year during which the certification is issued.
2. When applying for certification for a second or subsequent year, the organization shall include with its application a detailed report of its activities for the prior 12-month period, including statistics on the number of individuals served, the location and type of services provided, and any other information required by the {insert appropriate state department}.

Section 8. Taxpayer May Not Have Financial Interest in Charity.

No credit is allowed for a contribution made to an organization if either of the following conditions applies:

1. The taxpayer or a member of the taxpayer's family is an officer or employee of the organization.
2. The taxpayer, a member of the taxpayer's family, or a {insert appropriate percentage e.g. thirty-five percent } controlled entity of the taxpayer or a member of the taxpayer's family engages in significant activities with respect to the organization.

Section 9. {Severability clause}

Section 10. {Repealer clause}

Section 11. This act is effective for taxable years beginning on or after {year}.

7. Appendix I: Survey Results

Question 1: Would you favor or oppose a proposal that gives taxpayers the right to deduct up to $200 from their state taxes if they give an amount up to $200 to a private charity that helps the poor?

This survey was conducted by the Beacon Hill Institute as part of its State-of-the-Household Project. It was completed under the supervision of Dr. John Blydenburgh of Clark University and with the assistance of Commonwealth Consulting. The survey of 590 Massachusetts residents was conducted October 4-8, 1997 and has a margin of error of + 4%.

Question 2: Would you be more inclined to give to charities that help the poor if you got a more generous tax break for giving?

Question 3: If you were to donate $100 to help the poor, to which one of the following would you be most likely to give all the money?

Question 4: If the government cut back on welfare spending, would you be more inclined to give to charities that help the poor?

Questions 2 through 4, were part of a survey of 400 Massachusetts voters that was conducted from January 11-13, 1998 and that has a margin of error of + 4%. It was conducted for the Beacon Hill Institute under the supervision of Dr. John Blydenburgh of Clark University and with the assistance of Commonwealth Consulting. Numbers may not add up to 100% due to rounding.

Appendix II: Beacon Hill Institute Nonprofit Organization Survey Results

Footnotes

^[1] James P. Angelini, William F. O'Brien, Jr., and David G. Tuerck, Giving Credit Where Credit is Due: A New Approach to Welfare Funding (Boston: Beacon Hill Institute, December 1995).

² See David G. Tuerck and William F. O'Brien, Jr., A Charitable Tax Credit for Arizona: A Report to the Arizona House of Representatives Committee on Block Grants and Welfare Reform (Boston: Beacon Hill Institute, February 1997).

^[3] Ibid.

^[4] David G. Tuerck and William F. O'Brien, The Compassion Tax Credit: A Family Advocate Pilot Program (Boston: Beacon Hill Institute, November 1996).

^[5] This list is not exhaustive, but only indicative of the types of tax credits that states currently offer. State enterprise zone tax credits are common, however the regulations differ from state to state.