The Effects of Making the Charitable Deduction Above-The-Line

Tax Policy – The Effects of Making the Charitable Deduction Above-The-Line

According to recent reports, lawmakers are considering a proposal that would allow all taxpayers to claim the charitable deduction, rather than just those that itemize. Currently, about 70 percent of U.S. households choose to take the standard deduction, which means that they forgo the opportunity to deduct their charitable contributions. Under this proposal, the charitable deduction would become an “above-the-line” deduction, available to all taxpayers, whether or not they itemize.

This proposal is particularly relevant in the context of Republican tax reform proposals that would cause fewer taxpayers to itemize their deductions. Both the House Republican “Blueprint” and the Trump administration proposal would greatly increase the standard deduction and eliminate many itemized deductions. These two changes would lead many taxpayers to choose to take the standard deduction instead of itemizing, which would decrease the number that claim the charitable deduction. The House Blueprint, for instance, specifically aims to reduce the number of taxpayers that itemize “to approximately 5 percent.”

For some, the fact that the House Blueprint would lead fewer taxpayers to claim the charitable deduction is a feature, not a bug. After all, a major goal of tax reform is to decrease the size and scope of deductions and other targeted provisions in the tax code, in order to broaden the tax base and lower marginal rates. However, others are wary of any tax changes that would reduce the usage of the charitable deduction, which could lead to fewer charitable contributions.

Making the charitable deduction into an above-the-line deduction would make it more widely available, but would also come with trade-offs. For one thing, doing so would reduce federal revenue, because more taxpayers would be able to reduce their taxable income by deducting charitable contributions. We estimate that, under current law, making the charitable deduction above-the-line would reduce federal revenue by $191 billion over ten years.

Change in federal revenue from converting the charitable deduction to an above-the-line deduction (2017-2026)
Source: Tax Foundation, Taxes and Growth Model (March 2017 version). Estimates assume no change in household charitable giving.
In the context of current law In the context of the House GOP Blueprint
-$191 billion -$515 billion

In the context of the House Blueprint, the revenue loss from making the charitable deduction above-the-line would be even greater, $515 billion over ten years. This is because the overall structure of the House Blueprint would cause so many taxpayers to take the standard deduction and to stop claiming the charitable deduction. Thus, making the charitable deduction above-the-line would effectively restore the deduction for these taxpayers, which is why doing so would be so costly in the context of the House Blueprint.

These revenue estimates assume that modifications to the charitable deduction would not result in changes to household charitable giving levels. In reality, making the charitable deduction above-the-line would likely lead to higher charitable contributions by U.S. households, which means that the true cost of this proposal is probably higher than the estimates shown above.

Another trade-off associated with this proposal is that it would slightly alter the distribution of the federal tax burden. For instance, in the context of current law, making the charitable deduction into an above-the-line deduction would deliver the largest benefits to households in the top 1 percent, as well as to middle-income households. In the context of the House Blueprint, the benefits of making the charitable deduction above-the-line would be even more skewed toward high-income earners.

Change in after-tax income by quintile from converting the charitable deduction to an above-the-line deduction
Source: Tax Foundation, Taxes and Growth Model (March 2017 version). Estimates assume no change in household charitable giving.
  In the context of current law In the context of the House GOP Blueprint
0% to 20% 0.01% 0.00%
20% to 40% 0.07% 0.11%
40% to 60% 0.16% 0.25%
60% to 80% 0.17% 0.35%
80% to 100% 0.14% 0.48%
90% to 100% 0.13% 0.47%
99% to 100% 0.20% 0.50%
ALL 0.14% 0.38%

One other interesting consequence of making the charitable deduction into an above-the-line deduction is that doing so would almost certainly lead to decreased usage of the home mortgage interest deduction. This is because, if the charitable deduction were no longer an itemized deduction, fewer households would decide to itemize. As a result, fewer households would claim the home mortgage interest deduction.


Source: Tax Policy – The Effects of Making the Charitable Deduction Above-The-Line

What Would “Unprecedented Capital Expensing” Look Like?

Tax Policy – What Would “Unprecedented Capital Expensing” Look Like?

Yesterday, Republican leaders from Congress and the White House released a joint statement outlining principles for tax reform. While the statement did not include a great deal of detail, it did set out a few specific goals for a tax reform effort this fall:

The goal is a plan that reduces tax rates as much as possible, allows unprecedented capital expensing, places a priority on permanence, and creates a system that encourages American companies to bring back jobs and profits trapped overseas.

One of the objectives outlined in this yesterday’s statement is to allow “unprecedented capital expensing.” What does capital expensing mean, and what would an unprecedented level of it be?

Under the current U.S. tax code, businesses are usually allowed to immediately deduct their regular business costs. However, this is not the case for capital investments, such as equipment, machinery, and buildings. When a business makes a capital investment, it is required to deduct the cost over several years, according to a set of depreciation schedules. Not only is the system of depreciation deductions quite complicated, but there is good reason to believe that requiring businesses to deduct their capital expenses over time acts as a significant barrier to business investment, economic growth, and job creation.

“Capital expensing” refers to any law or proposal that would allow businesses to immediately deduct some or all of the cost of a capital investment.

Currently, there are two important provisions in the U.S. tax code that allow businesses to expense some of their capital investments:

  1. Bonus expensing allows businesses to deduct 50 percent of the cost of eligible machines and equipment. However, bonus expensing does not apply to all business investment, because investments in buildings and other structures are not generally eligible for the provision. In addition, bonus expensing is set to expire at the end of 2019.
  2. Section 179 allows small businesses to expense up to $500,000 in capital investments. However, section 179 begins to phase out for businesses with over $2,000,000 in capital investments, and businesses with over $2,500,000 in investments are ineligible for the provision. Additionally, section 179 also does not generally apply to structures, such as buildings.

However, in the past, the tax code has allowed greater use of expensing for U.S. businesses. For instance, beginning in September 2010, the U.S. tax code allowed 100 percent bonus expensing for equipment and machines placed into service before January 2012. Nevertheless, this level of bonus expensing was only temporary, and the provision reverted to 50 percent bonus expensing, where it currently stands.

If lawmakers are interested in offering “unprecedented capital expensing,” they would probably, at a minimum, have to allow for 100 percent permanent bonus expensing for equipment and machinery. They would also have to maintain or expand the current section 179 thresholds.[1] Lawmakers should also improve businesses’ ability to deduct the cost of structures, such as buildings, which do not generally qualify for section 179 or bonus expensing.

Many lawmakers have proposed going further than these proposals, and enacting a policy of “full expensing,” allowing businesses to immediately deduct the full cost of all of their capital investments. For instance, full expensing was a central part of the House Republican tax plan, released last summer. Full expensing would create a level playing field between all sectors of the economy, and would only help businesses that are undertaking new investments, which makes it one of the most pro-growth tax proposals currently under consideration.

However, yesterday’s joint statement shied away for calling explicitly for full expensing. Perhaps this may be due to lawmakers’ concerns about the potential federal revenue loss from moving to full expensing (although these fiscal costs are often overstated).

If lawmakers do not pursue full expensing for all assets, they may still be able to reduce the negative effect of the tax code on investments that cannot be expensed. For instance, lawmakers could increase the depreciation deductions that businesses receive in the future for their capital investments, adjusting the deductions for inflation and the time value of money. This approach is known as neutral cost recovery, and it would cause less of an up-front revenue loss for the federal government than full expensing.

Either way, it is encouraging that lawmakers have made increasing capital expensing one of their priorities for tax reform.


[1] To give a sense of what “unprecedented capital expensing” would look like, under current law, businesses are able to immediately deduct an average of 34.4 percent of the cost of their physical capital investments. In tax year 2011 – when 100 percent bonus expensing was under effect for equipment and machinery – U.S. businesses were able to immediately deduct 49.8 percent of their physical capital expenses. This is probably the figure that lawmakers have to beat if they wish to offer U.S. businesses “unprecedented capital expensing.”

(Calculations done by author using IRS statistics).


Source: Tax Policy – What Would “Unprecedented Capital Expensing” Look Like?

Comments on Today’s Joint Statement on Tax Reform

Tax Policy – Comments on Today’s Joint Statement on Tax Reform

Today, Republican leadership from the House, Senate, and White House released a statement that outlined their principles for tax reform. The statement provided few specific policy details, but emphasized principles that reform should follow. Many of these principles, probably by design, reflect some of the proposals already outlined in both Trump’s tax proposal and the House GOP plan, which contain policies that would help improve the tax code.

The Three Broad Principles in the Statement

The statement outlined three broad principles or goals for tax reform:

  • Simpler, fairer, and lower taxes for families,
  • Reduced and reformed taxes for businesses, and
  • Permanence

The principles reflect many of the policies that both the House GOP and the administration have included in previous plans. For instance, both the House GOP and administration plans have put forth policies to simplify the tax code. The House GOP’s plan, for example, would greatly increase the standard deduction and eliminate most itemized deductions. Both the administration and the House GOP also put forth ideas to reform the corporate income tax by reducing the statutory tax rate, broadening the base, and moving away from a worldwide tax system.

It is encouraging that the joint statement on tax reform reiterated the need to enact tax reform that is permanent, since temporary tax cuts would do little to encourage growth. Given that budget reconciliation rules prohibit legislation that adds to the deficit beyond a 10-year window, lawmakers will need to consider proposals and base broadeners that offset rate cuts and other proposed tax reductions.

No More Border Adjustment

One policy mentioned in the statement was border adjustment. This policy would have included imports in the business tax base while exempting exports, converting the federal income tax into a destination-based tax. The statement indicated that Republican lawmakers will no longer be pursuing this policy.

Removing the border adjustment isn’t necessarily detrimental to the growth prospects of tax reform. The border adjustment is trade neutral and would not distort economic activity. However, without the border adjustment, there are two major issues that policymakers will need to address.

First, revenue. Without the $1.3 trillion the border adjustment would raise, lawmakers will either need to find additional revenue raisers or spending cuts to offset the cost of a lower corporate income tax rate, or pursue rate cuts that are much less ambitious.

Second, preventing base erosion. The border adjustment accomplished an important goal: it prevented base erosion due to corporations shifting profits overseas. Without the border adjustment, lawmakers will need to carefully consider how to design a territorial tax system that eliminates many of the perverse incentives in our current system, but also prevents base erosion.

“Unprecedented” Expensing

The other policy mentioned by name was expensing. In the statement, lawmakers promise to enact “unprecedented capital expensing.” One could interpret this as a move away from the House GOP’s idea to allow companies to fully expense capital investments. If the GOP end up backing away from this proposal, it would mean that they should probably expect less substantial economic growth from their tax reform plan. Full expensing is probably the single-most pro-growth proposal that could be enacted as part of tax reform. However, this statement may also mean that lawmakers may look at other ways to improve cost recovery besides immediate expensing of capital investment.

Today’s statement outlined many laudable goals for tax reform. Tax reform should make the code simpler, reform business taxation in the United States, and be permanent. A reform that accomplished these goals would reduce the burden of the tax code on Americans and grow the economy.


Source: Tax Policy – Comments on Today’s Joint Statement on Tax Reform