FaxSheet December 1995: A Compassion Tax Credit

BHI FaxSheet: Information and Updates on Current Issues

A Compassion Tax Credit

December 1995

Welfare reform is on the way, but most welfare-reform proposals merely shift control of welfare spending from federal to state government. As long as welfare is taxpayer funded but government controlled, the seeds of poverty will be left freely to sprout new generations of poor.

A BHI Policy Study, Giving Credit Where Credit is Due: A New Approach to Welfare Funding, offers a proposal under which welfare will be taxpayer controlled and taxpayer funded. Individual taxpayers, both itemizers and nonitemizers, will receive a 100% federal tax credit for contributions to eligible charities for up to 25% of their federal tax liability. The tax credit will shift control of $115 billion of federal welfare spending from government to individual taxpayers. Some commentators have called this a compassion tax credit.

Eligible charities will be 501(c)(3) organizations that provide services now provided by government under means-tested programs such as AFDC, food stamps and housing assistance. These organizations will vie for taxpayer support by offering superior services to persons who now depend on government for assistance.

The Need for Radical Change
Why so radical a proposal? The existing system treats welfare as an "entitlement" rather than as temporary assistance offered on the condition of self-help by the recipient. The result is the creation of a cycle of welfare dependency.

A few facts show why the welfare system is broken. Although the poverty rate declined from 1959 to 1994, there are still more than 38 million Americans, or 14.5% of the total population, living in poverty. Poverty affects women and children more than other groups. The poverty rate was 54% for single, female heads-of-household in 1994. The poverty rate for children rose from 14.9% in 1970 to 21.8% in 1994. The percentage of households headed by single females rose from 9.8% in 1968 to 21.7% in 1993. The percentage of families headed by never-married individuals rose from .7% in 1968 to 8.1% in 1993.

These statistics stand out against a backdrop of a vastly expanded U.S. welfare system. In 1990, 11.5 million people received AFDC benefits. Government spending on direct public aid increased tenfold from $15 billion to $142 billion from 1970 to 1990. Yet, only 41% of all poverty-level families receive any government benefits at all. Only 23% of all poverty families live in public housing or receive housing benefits, and almost half of those receiving benefits are not poor. In other words, government welfare spending is highly inefficient. More than 2/3 of all federal welfare spending ultimately ends up in the pockets of people who are not poor.

Welfare recipients will receive at least the same level of support that they receive now. In this light, the existing entitlement is a Faustian bargain for recipients. Taxpayers and recipients alike would be better off under a system that eliminates the government middleman and creates instead a system under which taxpayers and recipients can arrange directly, with minimum intervention by third parties, the conditions under which taxpayer support will be provided. The compassion tax credit creates this system. It gives taxpayers an incentive to take interest in how their money is used and gives thousands of social-services workers an incentive to create new organizations for the purpose of channeling the increased flow of private donations directly to the poor.

Correcting for Welfare Myopia
Welfare is commonly viewed as something government provides. This view is highly myopic. Individuals give directly to private charities that perform services similar to those performed by the government welfare bureaucracy. Individuals give about $17 billion to programs eligible for the credit. This means that, for those programs, total spending is about $132 billion, equal to the $115 billion spent by government plus $17 billion spent by private charity.

Contrary to the myopic view, it can be shown that the total amount of welfare provided rises with the provision of a tax credit. This is owed to the expectation that tax incentives for charitable contributions lead to (1) increased giving, (2) increased voluntarism, (3) increased efficiency, and (4) reduced "crowd-out."

(1) Increased Giving. The provision of a tax incentive for charitable contributions amounts to a reduction in the price of private giving. This price is equal to the cost, after taxes, of giving an additional dollar. Under present law, the price of giving for a federal taxpayer in the 28% bracket is 72¢. A 100% tax credit reduces this price to zero (for donations up to the 25% limit). A 10% decrease in the price of giving increases charitable donations by 11.1%. Provision of a tax credit will cause private giving to expand by more than tax revenues contract and thus cause the total amount of welfare provided to expand.

(2) Increased Voluntarism. A recent Gallup poll finds that 29%, or 70 million, of all Americans volunteer their services to their communities. Social services receive 10% of volunteer time, while public benefit organizations receive 6%. Volunteer labor is twice as large as paid labor for religious and cultural organizations. People who volunteer their labor give more in charitable contributions. The creation of a tax credit will add at least 2 million people to the pool of volunteers for eligible organizations.

(3) Increased Efficiency. Of nearly 50 published papers, 40 find that private enterprise is more efficient than government at delivering services. There is strong evidence that private schools are able to offer a superior education for less money. While schools are not affected by this credit, they provide a good surrogate. Nonprofit organizations rely more on volunteers than either government agencies or private sector businesses.

(4) Reduced Crowd-Out. Government spending "crowds out" private giving. A one-dollar increase in government spending decreases private giving by about 10¢. By reducing government spending, the proposed tax credit will increase giving.

The proposal offered here is structured in such a way that welfare recipients will receive at least the same level of support that they receive now. Money now collected as tax revenue will be shifted to eligible charities as the tax credit reduces the price of giving. (Any moneys not shifted to such charities will continue to flow into existing federal programs.) Cost savings realized through reduced crowd-out and increased voluntarism and efficiency will generate a dividend to taxpayers and recipients.

This BHI FaxSheet is a synopsis of 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). Call 617-573-8750 for a copy of the full report.

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