Taxes Needn’t Discourage Philanthropy
"Taxes Needn't Discourage Philanthropy"
By Robert J. Shiller
Published July 29, 2012, in the New York Times.
Read the article in its original context on the New York Times website.
How high can taxes go? In 1944, the federal personal income tax rate reached 94 percent.
You might expect that such a high rate would lead to economic disaster or class warfare—or both. But it didn't. Despite it, people prospered back then, and at least in some respects, American society was harmonious.
World War II was raging, and perhaps because of it, people seemed to be more giving, while the government more actively encouraged altruistic acts. There are important lessons to be learned from that time.
Here are some of the facts: The government imposed that 94 percent rate on income above $200,000. President Franklin D. Roosevelt said in May 1940, even before the United States entered the war, that not a single war millionaire should be created, and by 1944 Congress essentially gave him the taxes he said he needed to head off the possibility.
The tax rate shifted after the war, but not by much. In fact, it remained extremely high for a very long time. In 1963, the top rate was 91 percent, but then it would be cut sharply, to 70 percent by 1965.
It is often argued today that high tax rates kill economic incentives, deterring talented business leaders from working as hard or taking as much risk. But how did the country fare during those years of super-high rates?
The growth of real gross domestic product was actually exceptionally strong. Using the years from 1948 to 1963, a period that omits wartime distortions, real G.D.P. grew 3.7 percent a year, on average, versus an overall 3.2 percent a year from 1929 to 2011.
There are many reasons for that, of course. But one factor was surely the high degree of social harmony of those 15 years. Many people sacrificed their lives during the war, and, for a while, it seemed that the survivors were especially charitable to one another, on both a personal and an institutional level.
It's natural for people to feel kind and generous toward those they perceive as behaving kindly and generously toward them. Unfortunately, the contrary is also often true: people tend to be vengeful toward those they believe have harmed them. Social psychologists and game theorists call this trait reciprocity.
Today, the top tax-bracket rate is only 35 percent (though it may go up slightly if the Bush-era tax cuts are allowed to expire at year-end). But what if we someday need to respond to another great national emergency, or even to a gradual crisis of worsening income inequality? We may again have to raise the top rates substantially—though I hope to much less than 94 percent!
First, we should think clearly about how capitalism worked under much higher rates for upper-income taxpayers. The tax burden wasn't quite as heavy as it might seem. The highest rate in 1944 applied only to income one earned over $200,000, which is about $2.6 million in today's dollars. Also, there were ways to avoid part of the burden—by means such as employers' giving employees untaxed perquisites or by paying them in underpriced stock instead of cash.
Still, for very high earned incomes, the bulk of the taxes couldn't be easily avoided. And people worried, then as now, that excessive taxation would eventually kill incentives for business.
In response, the government thought of creative ways to keep the incentives for high-income people alive, by letting them be philanthropists with much of their before-tax income. Notably, the maximum deduction for charitable contributions was raised from 15 percent of income in 1944 to 20 percent in 1953, to 30 percent in 1954, and then, with some qualifications, to 100 percent in 1956. (The maximum today is 50 percent.)
Because the long-term capital gains rate plus the income tax rate exceeded 100 percent, people in top brackets found that it was actually better, from a purely selfish viewpoint, to give highly appreciated assets to charity and take the deduction—and many did just that.
Some of these people were viewed as using the charitable deduction to avoid most of their taxes, so some philanthropy began to look like just a cynical tax dodge. That bad reputation still sticks somewhat today, though today's tax rates no longer permit making a profit by giving away assets. Governments should encourage philanthropy but not go that far: a gift must be a real gift.
Should charitable deductions be fundamental to financial capitalism? I argue so in my book, Finance and the Good Society (Princeton, 2012). We need to accompany any tax increases with an affirmation and a broadening of the tax system's support of philanthropy.
After a big tax increase on high incomes, people should have an especially strong incentive to give money to good causes: to the needy and to schools, colleges, hospitals, churches, the arts, and other purposes. Many such donations reduce the need for government spending, so the deduction isn't terribly costly to the government. It is also likely to bring entrepreneurial creativity to such causes.
Of course, there are counterarguments: that few people are motivated to work for money that will largely have to be given away, and that it's natural for people to want to make their families better off from their earnings. But there is an answer to that line of thinking: after one attains a certain level of comfort, greater wealth arguably contributes only to social status, which philanthropy certainly bolsters.
That's a good reason for national policies that encourage philanthropy. Although it's natural for people to want high social status, there are ways for high achievers to reach the same relative rank without so much wasteful conspicuous consumption, as Thorstein Veblen emphasized in his 1899 book, The Theory of the Leisure Class. (Robert H. Frank, my fellow Economic View columnist, has carried Veblen's torch into the 21st century, most recently in his 2011 book, The Darwin Economy.)
We already have a system to encourage philanthropy. It includes the charitable deduction, and ways for high-income people to set up their own philanthropic foundations, receiving a tax deduction each year as they donate. There are also donor-advised funds that are suitable for people with more modest incomes.
Unfortunately, much talk today focuses on just the opposite idea: curtailing the charitable deduction for high-income people, in order to help close the federal deficit. While the Bowles-Simpson bipartisan fiscal commission had a number of good ideas, it proposed cuts in incentives for high-income people to give. And President Obama again proposed cuts to the charitable deduction in his 2013 budget proposal.
Amid rising concern about inequality, we should focus on how we can improve our tax code and other rules to encourage positive feelings of reciprocity in our society. And we can do it while still giving people incentives to innovate—and to keep working hard.
Robert J. Shiller is professor of economics and finance at Yale.