We Need to Fix Problematic Charitable Giving Laws. The Biden Administration Can Help.

The recent exceptional generosity of philanthropists such as MacKenzie Scott deserves our applause. But we shouldn’t let their worthy actions blind us to the bigger problems facing philanthropy today: namely, that the laws promoting charitable giving no longer effectively serve their key purposes.

Here’s why: These laws offer giving incentives to too few donors, unfairly favoring wealthy taxpayers and degrading civil society in the process; they encourage donors to delay their giving, potentially for generations, and they increasingly fail to prevent fraud and abuse in charitable organizations, undermining trust.

Fortunately, all these problems have solutions ripe for pursuit by the incoming Biden administration. Here is a road map of where we are now — and the changes needed to move our tax policies in a better direction.

Create equitable incentives for giving. For more than 100 years, we have promoted charitable giving with a tax deduction. This signature success of tax policy has fostered a culture of giving that we now take for granted. But tax-law changes in 2017 drastically cut the number of households that could itemize their charitable deductions, resulting in some 21 million people losing their giving incentive practically overnight. That has left just one in 10 taxpayers with a tax incentive for donating — a startling contraction with wide-reaching effects.

As a practical matter, fewer donors mean fewer dollars, with one estimate suggesting a loss of several billion dollars a year in charitable contributions. Even more importantly, such a policy sends a signal from the federal government that only the gifts of the wealthiest 10 percent are worthy of a subsidy. Thus, a millionaire pays just 63 cents for each dollar of giving, while most everyone else pays a dollar.

Transparently unfair, this inequity also degrades civil society. A giving incentive for one narrow segment of the population amounts to a subsidy for the preferences of that group, while the choices and priorities of wider society are left out. With 90 percent of taxpayers excluded, the charitable world increasingly represents the interests of a limited donor class and not society as a whole, fostering elitism and inequity.

Favoring the giving preferences of the wealthiest perpetuates structural racism in philanthropy. The racial wealth gap is large and growing: The median and mean wealth of Black families is less than 15 percent that of white families. Since the charitable deduction is taken mostly by taxpayers with high incomes, who are much less likely to be people of color, the giving incentive ends up promoting the organizations and causes preferred by wealthy white people. Put simply, a tax policy that seems neutral in application, and noble in intent, has the unintended consequence of reinforcing systemic racism in the makeup of civil society.

The near-term solution is relatively straightforward and should be an easy call for the Biden administration. The White House should work with Congress to expand the giving incentive to all taxpayers. This idea already has bipartisan support, but lacks urgency on either side of the aisle.

Additionally, greater focus is needed on how to make a new giving incentive more equitable and cost-effective. Replacing the deduction with a credit, for example, would give everyone the same benefit and promote equity. Also, not every dollar given to charity needs a tax incentive. A minimum amount of giving, or a “giving floor,” should be required to trigger the tax benefit. This is a cost-effective way to better target the tax incentive and reduce false claims. Ultimately, these changes will result in a more equitable, fair, and inclusive civil society that reflects the giving preferences of our diverse nation.

Strengthen requirements for donor-advised funds. As we expand giving incentives, we must also make them work better. Most people are surprised to learn that the charities that raise the most money are not working nonprofits at all, but financial intermediaries affiliated with for-profit investment firms such as Fidelity, Schwab, and Vanguard. These firms set up separate entities that manage charitable funds for donors. Through these donor-advised funds, or DAFs, donors get a deduction but retain what the law calls an “advisory privilege” to grant the money to a charity at some future date. Donors have no incentives or requirements to ever distribute that money, and they can even pass their advisory privileges on to their heirs.

Not surprisingly, DAFs have grown in popularity, now holding $120 billion and accounting for roughly 12 percent of gifts by individuals, according to Giving USA. In 2019, they took five of the six top spots of the charities that raise the most from private sources.

Dollars awarded from DAFs do provide a significant source of funds for charitable organizations, but they also institutionalize a model of giving that allows donors to deduct now and give later — denying charities access to donated funds. This is backward. Charities need funds now to do their work. The giving incentive should encourage outright gifts — not unfinished giving.

The answer to the problem can largely be found in the work of a new coalition, the Initiative to Accelerate Charitable Giving. This group argues for new incentives or requirements for DAFs to distribute their funds within a reasonable time to speed up delivery to charities. This would work by either tying the deduction to when the money comes out of the DAF or by providing for a 15-year time frame to complete the gift. The Biden administration should look carefully at these proposals and promote ideas that will get more funds to charities faster.

Stop fraud and abuse. The IRS approves without serious review more than 85,000 new charities a year, while rejecting less than 100. Once approved for tax benefits, further review is unlikely. Charities and other nonprofits together file more than 1.5 million tax forms a year, but the audit rate is infinitesimal. Increasingly, organizations and individuals disregard or flaunt basic rules against self-enrichment, partisan political activity, or tax shelters. The erosion of legal standards tarnishes the halo of all the good organizations and undermines our trust in civic institutions.

Myriad reasons account for the IRS’s weakness when it comes to its role in nonprofit oversight. Most fundamentally, the agency is set up to collect revenue, not to promulgate and enforce standards about charitable behavior. And nonprofit oversight requires the IRS to partake in sensitive questions about issues relating to partisan activity, propaganda, and donor privacy that they are ill equipped to handle.

To tackle the problem, a first step may be to build consensus among lawmakers, nonprofit associations, and others who have a stake in charity regulation about the importance of oversight. The Biden administration should appoint a commission to study new approaches for how government oversees and enforces requirements for nonprofits. In addition, the administration, with congressional support, should seek to clarify rules about partisan activity by nonprofits and revisit the streamlined application process through which new organizations easily gain charitable status.

With a slim Democratic majority in both chambers of Congress, the Biden administration should demand tax-code reforms that encourage outright charitable giving by all Americans and restore trust through better oversight of nonprofit organizations. Such steps will go a long way toward revitalizing the nonprofit world and opening the door to a wide and diverse set of donors.