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Estate Tax Repeal and Charitable Giving

October, 2011 Update - Summary of Studies Compiled by The Chronicle of Philanthropy
The following link from The Chronicle of Philanthropy includes a list of over 30 studies and materials on charitable giving and tax policy.  Sumption & Wyland was pleased to be consulted and to have contributed to this list:
May, 2006 Update -- US House Study Reviews Literature, Advocates for Estate Tax Repeal

The Joint Tax Commission of the US House of Representatives issued a 41-page report dated May, 2006 titled “Costs and Consequences of the Federal Estate Tax”. The executive summary says, in part:

“This study examines the arguments for and against the federal estate tax, finding that the benefits of the tax are often overstated, and in any case are far smaller than the documented costs. In light of this finding, there is no compelling reason to keep the tax, and a number of reasons to reduce or abolish it.”

“The benefits of the charitable deduction are often overstated, with recent research indicating the tax has only a modest, if any, impact on gifts to charity.”

August, 2004 Update -- CBO Study Adds Nothing to the Debate

The Congressional Budget Office issued a report in July, 2004, “The Estate Tax and Charitable Giving.” The report was requested by U.S. Sen. Max Baucus (D-MT). This short report summarizes work described below in more detail and really adds nothing to the ongoing debate over estate tax repeal. As Paul Schervish says:

“Our major response at this point is that it still does not separate in the analysis estates that pass to spouses (and in which there is little charitable giving) and final estates in which most of charitable giving shows up. Also, it fails to analyze estates at the top differently from those lower down. Those at the highest end, so goes the talk on the street, are already limiting the amount they give heirs. Hence, increase in wealth derived from estate tax repeal would go to increasing the expected rate of return (because estate taxes take over 50% of gains on profits) on new investments and businesses and to increasing philanthropy.”

Here's our original article and discussion:

The December 15, 2003 issue of The NonProfit Times featured an “Estate Tax” column by Jeff Jones titled “Permanent Repeal - Charities Would Lose $10 Billion.” The column was based on an OMB Watch report that, in turn, was based on a report by two Brookings Institution researchers, Jon M. Bakija and William G. Gale.

Tempest in a Teapot
The ultimate problem with this faulty conclusion is that this is a tempest in a teapot. Even if all the assumptions were true (and there are several mitigating caveats that can be reasonably posited), the $10 billion decrease in annual gifts and bequests combined represents less than 5% of annual charitable giving, is concentrated in large-scale nonprofit institutions best able to adapt to changing circumstances, and includes both direct operating gifts as well as endowment principal gifts (both to institutions and to private foundations) -- gifts which annual impact is muted by foundations' distribution policies.

This relatively small number is dwarfed by the more than $30 billion, or almost 20%, increase in charitable giving from 2000 to 2002, according to the American Association of Fund Raising Counsel's “Giving USA” reports.

[Note: Most recent year giving reported in AAFRC's "Giving USA" reports are often revised upward in the first subsequent year, due to IRS reporting delays. The 2001 number reported in 2002, for example, was revised upward by more than $25 billion (12%) in the 2003 report. Therefore, it's reasonable to use two-year rolling averages as a way of mitigating the underreported most recent year giving.]

What Works for the Nation Doesn't Work for the States
What The NonProfit Times column reported, and the OMB Watch report presented as factual, are conclusions based on very shaky evidence that the original Brookings researchers (Bakija and Gale) would find difficult to endorse. Further, OMB Watch uses the wide range of impact theorized by Brookings (anywhere from 22 to 37 percent of bequests from estates subject to federal estate tax) to compute gross “losses” that are then allocated to states and charities as averages, without regard to the size of a charity, its philanthropic mission, or its history or likelihood to attract gifts - of any type or size - from donors subject to estate tax.

This arithmetic sleight-of-hand makes for good regional and local press releases, but badly distorts even the global case Bakija and Gale sought to present. I have also confirmed that Bakija and Gale never intended for the data to be used in this way, and only present their model and data as national aggregates, not state-by-state impacts.

Estate Tax Repeal Affects Annual Giving?  
Bakija and Gale assume that only half the losses will be attributable to loss of estate tax-related charitable bequests. They assert that these bequest losses will double because high net worth donors will reduce annual giving. Why? Apparently, because these donors no longer have the motivation to give their money away during life to avoid having it taxed at death.

They cite a study by US Treasury economists that indicates that repeal of the estate-tax would cause wealthy individuals to reduce their charitable giving by 12% in the last year of life. Bakija and Gale then hypothesize that giving throughout life is “similarly sensitive to giving in the last year of life,” and, based on this hypothesis, say that a $5 billion decrease in annual giving is “implied.”

There are two problems with this assertion. First, the studies do not control for other factors influencing annual giving toward the end of life, such as: 1) decreased annual income after retirement affecting disposable income; 2) diversion of income and assets for other purposes without regard to estate tax considerations; 3) the fact that surviving spouses (usually women) are more frugal with estates left by predeceased spouses; and 4) in the last year (or few years) of life, philanthropic activity may be affected by deteriorating health, mental acuity, and related factors.

The second problem is that the financial impact associated with the assertion is subject to wild fluctuations. The researchers supporting this idea describe wide ranges of impact. One researcher cites an impact of “from 13 to 31 percent” reduction in annual giving by estate tax-subject individuals in the last ten years of life.

Giving Isn't Just About Tax Avoidance
No explicit mention is made in the OMB Watch report about the charitable intent of wealthy donors, apparently assuming that these donors give, primarily or exclusively, for tax reasons. The Brookings study acknowledges that donors' willingness to give, independent of tax consequences, is a variable that could reduce their study's wide range of estimated charitable impact from estate tax permanent repeal.

Where Does the Money Go?
Another variable overlooked in the studies is where charitable bequests actually go. There appears to be no differentiation between estate tax-influenced gifts to operating charities and those to endowments and private foundations. Even assuming the studies' premise that giving would decrease, at least some of that decrease would only be felt derivatively, through a loss of present disbursement capacity by endowments and foundations funded through these particular gifts.

For example, my estate leaves a $1 million gift to a private foundation or endowment. Typically, only 5% of that amount is disbursed by the foundation each year. So, the “$1 million loss” is actually a loss of $50,000 in any given year. [Note that the increase in asset value would result in proportionate increases in disbursements; however, inflation would have to be taken into account, so the long-term impact in constant dollars would be less than raw investment returns would indicate.]

Don't Believe What You Read
So, OMB Watch issues a derivative report using gross assumptions and erroneous methodology to present data that the original researchers identify only in terms of wide ranges, with mitigating variables not taken into account, resulting in conclusions that the Brookings researchers can't support. This OMB Watch report then becomes the headline for a trade publication article, misleading readers.

The Other Side of Academia
There are researchers on the other side of the question. However, their research has its own limitations and assumptions.

Paul Schervish and John Havens of the Social Welfare Institute at Boston College demonstrated that charitable bequests, and percentage of funds left to charity, increased at dramatically greater rates in the 1990's than did the overall value of estates subject to estate tax. Further, the wealthiest estates ($20 million and above) are more likely to dedicate a higher percentage of total worth to charity than are smaller estates ($1-19 million). Schervish and Havens posit that permanent repeal of the estate tax will inject more money into the economy, allowing more people to give more over their lifetimes.

Bankers Trust Private Banking published a study last year indicating that, without the restrictions placed on estate planning by the estate tax, most donors, and especially the wealthiest, would give more support to charity than they do under the present system.

In fact, charities' “competition” for bequest dollars isn't with greedy heirs, it's with the tax collector. Without the estate tax, charities receive more of the freed-up funds than do heirs, according to the Banker's Trust study. Schervish writes: “In other words, if those wealthy people get their wish, their 76% reduction in taxes would result in a 63% increase in bequests to charity.”

Unfortunately, the Banker's Trust study is almost anecdotal, using a very small statistical sample. Therefore, generalizing from it is a dangerous proposition.

Bakija and Gale see increasing bequests to charity as deliberate activity by wealthy and super-wealthy donors to escape the estate tax. Schervish sees it as deliberate activity to increase benefit to charity as net worth increases.

The Bottom Line, or Where Do We Go from Here?
Whether one believes the doom-and-gloom of OMB Watch and Brookings or the rosy scenario of Boston College, one key factor is missing from both approaches: the adaptability of nonprofits to raise funds without the estate tax as an inducement.

Most development officers' planned and deferred giving discussions begin with a discussion of the basics of the estate tax and how it will affect potential donors. The discussion then moves on to discussing ways a wise donor can legally maximize the value of their estate while providing philanthropic support to the charity or charities of their choice. Alternatively, the discussion moves to how to maximize a charitable gift while preserving wealth.

Even if we assume that charitable giving is affected by estate tax, and that fluctuating estate tax rates cause changes in donor behavior, must we assume that permanent repeal means that donor behavior will continue the same changes? In other words, if a radio's volume is decreased, the listener will strain to hear the program. If the radio is turned off, will she sit in silence?

Must we assume that, without an estate tax, these discussions between donors, charities, and investment professionals would no longer be happening? Isn't it more reasonable to assume instead that the text of the conversations would be changing? Wouldn't it be likely that enterprising nonprofits would develop new fund raising approaches, new giving programs and vehicles, and adapted prospecting and cultivation strategies to accommodate the new tax environment? Wouldn't investment professionals still seek to work with donors and charities to maximize the impact of philanthropic gifts?

Dire predictions based on vague data and overbroad assumptions don't make for informed policy choices, even when the impact is as small as that predicted by OMB Watch. Whether one supports or opposes permanent repeal of the estate tax, the data consistently indicate that the presence or absence of the estate tax will not have a statistically significant impact on overall charitable giving.

As nonprofit professionals, we need to have more faith in our supporters and in our profession - faith that our donors give for philanthropic reasons, and that we can continue to provide them with solid reasons and good methods to support the charities and causes we all believe in.

For more information:
AAFRC's “Giving USA” --
OMB Watch on Estate Tax --
Institution on Estate Tax --