Very wealthy men and women like Warren Buffett and Bill Gates would frequently create charitable foundations even if that did not help them avoid estate taxes on their wealth. After all, the estate tax was negligible when Rockefeller and Carnegie created their large foundations. Nevertheless, a sizable estate tax that exempts charitable giving has encouraged the creation of many large private charitable foundations in the United States.
Private giving to various causes is a substitute for public giving, and private giving tends to be more effective because of the competition among different foundations and other charities. In this respect I believe the US market for giving is much better than the European approach because financing of the arts, higher education, hospitals, and many other activities to a considerable extent comes from governments in Europe, while in the US these activities much more depend on fees for services and private donations. Competition among private donors is as conducive to efficiency and productivity growth in these fields as is competition among producers of cars and other such goods.
Although this will not be the main focus of my discussion, I support the abolition of the estate tax, or at least its significant weakening to cover only very large fortunes, perhaps along the lines of the recent bill on reform of the estate tax passed by the House of Representatives. The present estate tax is too discouraging to accumulations of moderate amounts of capital in small businesses and other ways. It also encourages legal and accounting spending devoted solely to finding and exploiting loopholes that is considerable relative to the tax revenue the estate tax raises (about $30 billion in 2005). If the concern is about inequality caused by inheritance, the tax should not be on estates, which may be divided up among a number of heirs, but on the amounts inherited by individuals.
Decentralized private charitable giving can be encouraged through the tax system even without an estate tax, as long as charitable contributions can be generously deducted from income taxes. Indeed, as I argue below there are advantages from having foundations created while donors are alive rather than mainly after their death. However, if the estate tax were abolished or substantially weakened, it would be desirable to raise significantly the cap on giving in the federal tax code-set presently at 30% of adjusted gross income- to a much higher per cent, perhaps 100 % or even higher (if higher than 100%, there might be a loss carry over provision).
This brings me to my main topic, Warren Buffett's announced gift of over $30 billion to the Bill and Melinda Gates Foundation. It is unusual in that this amount and any interest earned are supposed to be entirely spent by the time the Gates' have either died or no longer run their foundation. Even more rare for such a large gift is that Buffett is not creating a foundation with his name, but instead is giving the money to a foundation created and soon to be managed by his friend, Bill Gates.
Most foundations continue long after the death of their creators, and after replacement of the initial managers and Boards. This commonly leads to a shift away from the donors' intent. Partly that is desirable given unanticipated changes in the social and economic environments, and in the resources supplied by other donors and by governments. Most people recognize the need for foundations to react to these fundamental forces, but another type of change over time in foundation goals is more disturbing. Self-made businessmen who usually have strong beliefs in capitalism and a competitive market system create many of the large foundations. Such "conservative" views often guide the early days of their foundations' activities, partly because the donors choose managers and Boards who are sympathetic to their beliefs.
Over time, however, foundations frequently become more liberal, as management and Boards change. Although the market for foundation executives is highly competitive, these executives typically come from education and family backgrounds that are similar to those of modern journalists. As a result, foundation executives also tend to have a "liberal" outlook on the role of government, and the most pressing social and economic questions. This liberal outlook often clashes with the views of the original creators of the foundations they manage.
Examples of the shift from conservative to liberal over time include the large Ford and Pew Foundations. Some foundations created after the death of a conservative donor, such as the MacArthur and Packard Foundations, from the start have a much more liberal orientation than the donors. I do not know of any prominent examples that moved the other way, from initially liberal to becoming conservative over time. A solution to the problem of the shift over time away from the intent of donors is for donors to require that their foundations give away all their assets by a set date, or shortly after their deaths or that of managers they trust. The Olin foundation is the most prominent large foundation that was directed to, and did, succeed in giving away its assets by a set date. It accomplished that goal, under the leadership of William Simon and James Pierson, while giving its money in a thoughtful manner, such as funding a number of prominent Law and Economics programs at Law Schools.
Warren Buffett believes in capitalism and competitive markets, but he is not a "conservative". Still, he is concerned that over time his huge gift would be used in ways that he would not approve. So he is following the example set by Olin and a few other foundations, and he is installing a sunset provision that would require all his charitable assets to be spent by the time the Gates" have either died, or withdrawn from an active role in their foundation.
Even more unusual is his decision not to set up a new foundation under his name, but to give the bulk of his fortune to the Bill and Melinda Gates Foundation. He has chosen to place his philanthropic money in the same manner as he invests the money in his funds; namely, by picking managers that he believes will use the money well and yield a high return. The only difference between spending charitable and investment monies is that the former yields returns in the form not of profits, but in terms of effectiveness in furthering the donor's aims. The Gates foundation has so far been spending most of its money on promoting health in developing countries through attacking diseases that are more common in these countries, such as malaria. From the little I know about this foundation, it has spent its money relatively well. So it does not seem surprising that Buffett has confidence in this particular foundation.
What Buffett is doing may be wise, but is very uncommon because most large donors want their names on the Foundation they create, and also on the organizations sometimes set up by recipients of their gifts. Even the Olin Foundation generally called the Law and Economics Centers they created after Olin. That Buffett could resist the temptation to have a foundation monument in his name testifies not only to his wisdom but also to the inner confidence of the man.