Effects of Estate Tax Reform on Charitable Giving

Since 1916, the United States has imposed a tax on the estates of the wealthiest individuals. The 2001 tax cut reduces the estate tax over time, and then repeals it as of 2010, only to reinstate it in 2011. Because politicians are unlikely to allow this pattern of changes to occur, estate tax reform will return to the policy agenda in the near future.

One of the most important issues in assessing reform options is the impact on charitable giving. The estate tax encourages charitable giving at death by allowing a deduction for charitable bequests. It also encourages giving during life, as explained below. But the tax reduces charitable gifts by reducing the amount of wealth decedents can allocate to various uses. The net impact of these effects is ambiguous in theory.

We find that estate tax repeal would reduce charitable bequests by between 22 and 37 percent, or between $3.6 billion and $6 billion per year. Previous studies are consistent with this finding, and also imply that repeal would reduce giving during life by a similar magnitude in dollar terms. To put this in perspective, a reduction in annual charitable donations in life and at death of $10 billion due to estate tax repeal implies that, each year, the nonprofit sector would lose resources equivalent to the total grants currently made by the largest 110 foundations in the United States.1 The qualitative conclusion that repeal would signifi- cantly reduce giving holds even if repeal raises aggregate pre-tax wealth and income by plausible amounts.

Background

In 2001, charitable contributions totaled $212 billion, of which living individuals gave 76 percent, bequests accounted for 8 percent, and foundations accounted for 12 percent (AAFRC Trust for Philanthropy 2002). Estate tax changes can plausibly affect giving through all of these channels.

The remaining 4 percent was donated by corporations. Charitable bequests figure most prominently as a source of gifts for educational institutions, medical research institutions, museums, and the creation and maintenance of private foundations.

The federal estate tax currently applies to net estates in excess of $1 million. The net estate equals gross assets at death less deductions for debts, spousal bequests, charitable bequests, expenses of administering the estate, and a few other miscellaneous items. The marginal estate tax rate varies between 41 and 49 percent, with the rate rising as wealth does. The exemption is scheduled to increase in steps, reaching $3.5 million by 2009, while the top marginal tax rate is scheduled to fall to 45 percent, before the tax is temporarily eliminated in 2010.

In recent years, about 2 percent of decedents have had to pay federal estate taxes. Table 1 provides information on charitable bequests and wealth reported on federal estate tax returns filed in 2001. Most of these returns represent people who died in 2000, for whom the effective exemption was $675,000. Charitable bequests appeared on one-sixth of estate tax returns, and amounted to $16.1 billion, or 7.5 percent of the value of gross assets.

Both the likelihood of giving and the share of estate given rise significantly with wealth. These patterns are consistent with the incentives created by tax rates that rise with wealth. Of course, people may be willing to give larger shares of wealth to charity as their wealth rises for reasons other than taxes. In any event, charitable bequests are heavily concentrated among the wealthiest estates. In 2001, 301 decedents with gross estates in excess of $20 million gave $6.8 billion to charity. These decedents represented fewer than 1 out of every 8,000 deaths in that year, but accounted for 42 percent of all charitable bequests and made average bequests of $23 million. Likewise, 64 percent of all charitable bequests came from roughly 1,900 gross estates above $5 million.