The Gates Foundation and the Estate Tax--Posner's Comment

Charitable donations last year totaled some $260 billion, given mainly by individuals; foundations gave only about 11 percent. Religious institutions receive about 40 percent of the donations; the next largest category, education, receives less than half that. Medical research, the arts, environmental groups, and victims of poverty and disasters are the other major recipient groups. It is generally taken for granted that charitable donations are a "good thing," because the donor is not getting anything in return and therefore must be motivated by pure good will. That is probably true of donations to victims of poverty and disasters; such donations are altruistic in the sense that the benefit to the donor comes from the fact that he internalizes the suffering of the victim. However, such donations account for little more than 10 percent of total charitable giving. Most other charitable gifts go to support services that the donor consumes directly (such as religion or environmental amenities) or indirectly--indirectly when for example a college alumnus donates to his college, the donation helping to maintain the college's prestige, a commodity that benefits the alumnus, or to gain admission to the college for the donor’s kids. There is nothing wrong with such spending, any more than there is with other lawful consumption choices. But it should not be confused with altruism. The only defensible rationale for a tax break to encourage such donations is that there is a free-rider problem which a matching grant (the effect of the tax break) can help overcome: the prospective donor who wants to increase his alma mater's wealth benefits from other alumni donations to his college and so may donate less than he would if he derived no benefit from those other donations. The government's matching grant, in the form of a tax break (so if the donor is in the 30 percent bracket, the government in effect pays $3 for every $7 that he donates), reduces the cost of donation: it costs him only $7 to enrich his alma matter by $10. If the charitable deduction from federal income tax were eliminated, there would be less charitable giving, but income tax rates could be lowered without loss of government revenue. Because free-rider problems are a source of genuine inefficiencies, there would be a reduction in allocative efficiency from this change. But income tax like other taxes creates allocative inefficiency as well, and that inefficiency is reduced by reducing the tax rate. So it is not clear that there would be any net increase in inefficiency from eliminating the charitable deduction. Since charitable bequests are exempt from the estate tax, abolishing that tax would lead to a reduction in such bequests; an effect of 6 to 12 percent has been estimated. The negative efficiency effect of eliminating the government's matching grant for charitable donations would not be offset by lower income tax rates; those rates would have to be raised to make up for the shortfall in tax revenue caused by the abolition. Unlike Becker, I do not favor the abolition of the estate tax. Apart from the effect of abolition on the charity free-rider problem, the tax appears to be relatively efficient. The tax falls mainly on very wealthy people, who are unlikely to give away all their wealth during their lifetime in order to beat estate tax. Indeed, for people who have no bequest motive and die with assets only because, not knowing exactly when they would die, they did not want to pauperize themselves, the tax has minimal misallocative effects. Suppose there were a 40 percent estate tax on estates of $1 billion or more and a back-up 40 percent gift tax on gifts, including charitable donations, by billionaires. The Gates foundation, as enriched by Warren Buffett's gift, will have assets of some $60 billion, and under the assumption of a 40 percent gift tax $24 billion would have gone to the government, reducing the foundation's assets to $36 billion. There is no way in which Gates and Buffett could consume $60 billion in the remainder of their lives, so probably such taxes would not have deterred the gifts. It might seem that the critical question would then be whether the government or the Gates foundation would spend the $24 billion more efficiently. But that is not correct. Assuming that total tax revenues were not intended to be altered by the imposition of the 40 percent gift tax, the $24 billion in gift-tax revenue would be returned to taxpayers in the form of a reduction in their income taxes or other taxes. The question would then be whether the taxpayers or the Gates foundation would spend the money more efficiently. I believe the taxpayers would. The foundation is an inherently inefficient allocative institution because, much like the government, it is not subject to market tests. There is no way to assess the value of the Gates foundation’s expenditures because the foundation is not competing in any product or capital market. (Colleges and most other recipients of charitable gifts, in contrast, compete in product markets.) Gates and Buffett are extremely able businessmen but the Gates foundation is engaged in activities, such as fighting Third World diseases, that are remote from their business experience. Becker and Casey Mulligan have argued, with empirical support, that "efficient" taxes aren’t really efficient, because they enable government to grow, and government is inefficient. In recent years, however, we have seen a conjunction of tax cuts with rapid growth in government spending. Federal spending as a percentage of GDP rose from 18.5 percent at the beginning of the Bush Administration to 20.3 percent in 2005, the gap between tax receipts and expenditures being filled by borrowing, mainly from foreigners. Under present conditions, it is uncertain that making tax policy more efficient will stimulate further government growth.

Comments

[Arun Khanna]

I hope someone donates billions to start new universities with professional schools (not liberal arts) at the center and helm.

[David]

At least currently, the federal government is doing a particularly bad job of spending its discretionary funds, because the process has been corrupted by politics and cronyism. The Gates foundation, on the other hand, is funding innovative work across the globe and is willing to fund scientific and medical research, for example, that the current federal government will not fund for political reasons. So, I applaud Buffet's donation to the Gates foundation. This is an excellent use of the deduction for charitable gifts.

[Haris]

Judge Posner
I see a possible problem I see with your example with a 40% charitable gift tax with an offsetting reduction in income taxes. You argue that taxpayers would probably be better at spending the money than a charity would. I am not entirely sure that is true. The bottom 40% of Americans, for example, pay no income tax and thus would not benefit from decreased income taxes. Meanwhile, I am guessing that this group is the one that benefits the most from charitable activities. Isn't it possible that the return [in utility] to charitable expenditures is higher than to the expenditures of taxpayers? It seems to me that a dollar does much more for those at the bottom than those at the top. Unless the poorest also share in the rebate you suggest, I think it is at least possible that charities would be more efficient at spending the money.

[logicnazi]

An interesting argument but I think you overlook some important points.

First of all what the free market optimizes and what we want as a society are different things. The free market will optimize production and efficency while as a society we also value overall happiness and lack of suffering. I suspect that charitable giving turns out to increase total happiness more than comparable spending on personal recreation. This will be true if for no other reason that then relation between money and happiness is sub-linear. Thus it can overall be a societal good to encourage giving as oppossed to buying other goods.

Taxing gifts at a high rate would do just the opposite. It would strongly discourage people from giving as they could buy something for themselves without paying the 40% (the buisness is only taxed on profits not total price). Moreover, the psychological effect is likely to be much stronger than what rationality would dictate. Making charitable gifts tax deductable is a form of moral praise for the people making them thus removing this deduction even in a charity neutral way would have a negative effect.

Additionally imposing such a tax on private charities would encourage people to seek government run programs for their favorite causes. Even though such a program might be totally revenue neutral each particular cause has more of an incentive to have the government do the work rather than encouragin donations which will get taxed at 40%. In other words you increase the benefit for lobbying the government as compared to encouraging private donations.

[W]

I think the most efficient use of Buffett's billions is to bequeath it to Richard Posner. I am willing to bet that Richard Posner has no cogent rebuttal to this argument.

[Jake]

W, you make that statement secure in the knowledge that Judge Posner must be somewhat circumspect in his remarks, given his high public duties.

I personally believe that Posner would put Buffett's billions to very efficient use, for example, funding the sorts of scholarly inquiries he has pursued, to his readers' benefit, for several decades.

(I freely admit that I could misjudge Posner, who might truly be a moneygrubber hiding behind a beneficent public facade, but, then, I've read his works, which suggest nothing of the sort.)

[Jesse]

Posner has oversimplified the reasons for alumni donations to their alma mater. People often recall their undergraduate days with a great deal of fondness and that affection translates to donation.

If prestige-enhancing motivations dominate donative intent you would expect giving to one's professional or graduate institution would exceed giving to one's undergraduate institution. (Since the prestige of your terminal degree is much more likely to affect your career & income). I suspect the opposite is true. Does anybody have a different sense? Or data?

[O]

Posner assumes that a government's income from estate tax on large gifts would automatically reduce income tax for citizens. That's a bold assumption. In any case, it boils down to which of the two parties, government or foundations, are the more effective allocators of capital.

[Richard Mason]

In letters accompanying his bequests, both to the Gates foundation and to the smaller foundations run by his family members, Warren Buffett expressed the hope that the foundations would remain narrowly focused and concentrate their effort on just a few neglected issues.

http://www.berkshirehathaway.com/donate/webdonat.html

If we suppose that there is merit in such concentration of effort, it would tend to be thwarted by Judge Posner's scheme, which would effectively fracture the money between the concerns of a hundred million taxpayers.

[Richard Mason]

Jesse: If prestige-enhancing motivations dominate donative intent you would expect giving to one's professional or graduate institution would exceed giving to one's undergraduate institution.

Anecdote: The largest single gift to an institution of higher education, so far, is Gordon Moore's $600 million given to Caltech, where he got his Ph.D., not to Berkeley where he was an undergraduate.

I do not know if people with advanced degrees are more likely on the whole to give to their undergraduate schools, but if it is true that they are, that might also be explained by the "please let my kid in" theory of alumni giving.

[W]

W, you make that statement secure in the knowledge that Judge Posner must be somewhat circumspect in his remarks, given his high public duties.

Thanks for assuming the worst, but I am not Ronald Dworkin, i.e., I bear Richard Posner no ill will. I like the Honorable Judge Posner and his websiteand thought I would bring levity to his life with a delightful joke. But since you have no sense of humor, Jake, I suppose I should reply to the substance, or lack thereof, in your "argument," if the collection of sentences you managed to (drunkenly?) string together can be fairly construed as an argument. There is no reason to believe that Richard Posner lacks self-interest. If you believe that Richard Posner is Mother Teresa, then please explain why he doesn't sit on the 7th Circuit for free and why he didn't donate the proceeds of his many books to charity, Joke. I mean, Jake.

[Lesbian Reader!]

I personally believe that Posner would put Buffett's billions to very efficient use, for example, funding the sorts of scholarly inquiries he has pursued, to his readers' benefit, for several decades.

Like investigating the fashion-sense of lesbians, as he did in Sex and Reason? You're right, Jake, we need more inquiries like that one.

[N.E.Hatfield]

Just one observation. What's the current deficeit running at, in the trillions category? What's needed is more estate taxes, not less, given the income tax cuts everyone's gotten. That is, if one believes in operating a balanced budget.

Whatever happened to the "tax and spend" Democrats? Have they been replaced by "cut taxes and spend" Republicans. ;)

[N.E.Hatfield]

Hey Verve, What's your malfunction?

[Yong]

Posner made the point that most donations were given to organizations for services that the donor enjoys. I agree with this, and would add that many donations are not entirely voluntary. Some in fact appear to be coerced. Take my daughter's school, a high school, for example. Every few months it would send the parents a newsletter half of which is devoted to listing the names and amounts parents donated to the school. My wife and I donate to the school, we are however among the small donors and often feel inadequate for being listed among those who donate the minimal amount. Had we not been able to donate at all, I know we will feel embarrassed and very concerned. Embarrassed because we appear stingy. Concerned because we worry if the teachers would treat our daughter differently because her parents, who are named, are not as generous as others.

The result is every time we decide the amount to donate, we have to weigh it against not just the benefits to the school that my daugher enjoys, but also the potential level of embarrassment and if the amount's adequacy could adversely affect how my daugher is treated.

Perhaps, by making a big deal about his donation to the Gates foundation, Buffet had the undeclared objective of shaming the third richest man into giving up a portion of his wealth?

[Yong]

I wonder about the precision of Poser's comments about the benefit to the acceptor of a donation due to the tax break. He said:

"The government's matching grant, in the form of a tax break (so if the donor is in the 30 percent bracket, the government in effect pays $3 for every $7 that he donates), reduces the cost of donation: it costs him only $7 to enrich his alma matter by $10."

When an alumnus donates $7 to his alma mater, the university received $7, not $10. The government loses $2.1 tax which it would have received had the donor paid income tax on the $7.

The result is $2.1 less for the government which it could use support other worthy causes, such as defense, build a stronger dam, or to educate and provide healthcare to the children of the poor who may then go on to serve the government such as by fighting wars.

Had the university been a for-profit organization that pays income tax, then it seems to be that Posner's statement would be accurate in that the university would need to make $10 in order to keep $7.

In my view, it is questionable, even objectionable, that the government should lose revenue because of donation to religious organizations and universities. Tax deduction should be allowed only for activities that the government is permitted but unable to support such as diaster relief.

[Haris]

Yong
If a person makes $10 in income in a place with a 30% income tax, that person would normally pay $3 in taxes and keep $7. If instead the person donates all $10 to a charity, the money is not taxed in Judge Posner's scenario. Thus, the charity receives $10, while the person only loses $7 [the amount he would have otherwise kept], and the government loses $3.
Also, I doubt you will find many opponents to the government losing revenue. That is probably the best part of this whole scheme.

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