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December 13, 2012
How the Charity Deduction Made the World Safe for Philanthropy
Joseph J. Thorndike

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Ostensibly, the fiscal cliff has pushed a lot of sacred cows closer to the chopping block. Most of the biggest tax expenditures will probably escape the carnage of late December. But this won't be the last fiscal crisis that prompts lawmakers to take a skeptical look at big-ticket tax preferences.

Among the preferences getting new attention is the deduction for charitable contributions. Traditionally, Washington insiders have considered the preference almost untouchable. But some of the revenue raisers reportedly under consideration -- including limitations on itemized deductions -- are expressly designed to make the untouchable just a little more vulnerable. And if the current freakout among lobbyists for the nonprofit sector is any indication (a debatable presumption, because lobbyists have their own reasons to insist that the sky is falling), then the charity deduction might well be under some real pressure.

Which raises an obvious question, at least for those with a historical turn of mind: Where did this preference come from? Many of the arguments used to defend it seem timeless -- who wouldn't want to encourage charity, or at least lighten the load on those inclined to give? But like every provision of every law, the charity deduction has a specific history, rooted in particular circumstances. And as so often proves the case, at least for tax laws, the deduction got its start in the middle of a war.

Saving Surplus Income

The deduction for charitable contributions is one of the oldest preferences in the tax law, making its debut during World War I (after a failed effort to include it in the original 1913 tax law).1 The War Revenue Act of 1917 provided a deduction for:

    contributions or gifts actually made within the year to corporations or associations organized and operated exclusively for religious, charitable, scientific, or educational purposes, or to societies for the prevention of cruelty to children or animals, no part of the net income of which inures to the benefit of any private stockholder or individual, to an amount not in excess of fifteen per centum of the taxpayer's taxable net income as computed without the benefit of this paragraph. Such contributions or gifts shall be allowable as deductions only if verified under rules and regulations prescribed by the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury.2

According to its champions, the provision was necessary if charities were to survive the war. Heavy new taxes on incomes and estates threatened to dry up the reservoir of private funds that sustained these worthy organizations. Relieved of their "surplus" income by new levies, wealthy givers would simply stop giving. As Sen. Henry French Hollis explained:

    Usually people contribute to charities and educational objects out of their surplus. After they have done everything else they want to do, after they have educated their children and traveled and spent their money on everything they really want or think they want, then, if they have something left over, they will contribute it to a college or to the Red Cross or for some scientific purposes. Now, when war comes . . . that will be the first place where wealthy men will be tempted to economize, namely in donations to charity.3

Two things seem evident from this statement. First, the war was crucial to the deduction, because it had failed in peacetime and gained traction only when war taxes underscored the issue. Second, educational institutions seemed to figure prominently in the argument for creating a deduction. Hollis, in fact, emphasized in his remarks the degree to which higher education had come to depend on private philanthropy.4

On its editorial page, The New York Times echoed those concerns. The paper began by lamenting the class-based rhetoric that surrounded the rise in income and estate taxes. "Rich men are doing, and are willing to do, their part in this war," the editors wrote. "They are ready to pay, some of them have already paid, their children's lives to the defense of democracy; and they should be taxed, and are willing to be taxed, high. They ought not to be maligned in addition."5

Even more important than a rich man's feelings, however, were a rich man's donations. Higher education, in particular, faced a short-term crisis. "The Presidents of the colleges, whose incomes from tuition and dormitory fees will be notably lessened by the war service of so many collegians, so many 'rich men's sons,' and sons of the well-to-do, are in grave perplexity," the Times wrote.6

Those poor, perplexed presidents were the innocent victims of soak-the-rich tax policies. "There is a necessary social effect to this taxation of great incomes," the paper warned. "It diminishes or dries up the springs of philanthropic eleemosynary and educational life."7

The editors of The Washington Post were even more explicit in their warning to lawmakers. "This country cannot abandon or impoverish the great structure of private charity and education that has been one of the most notable achievements of American civilization," the paper implored.8

Saving Small Government

Most advocates of the new deduction pointed out that weaker charities meant stronger -- and bigger -- government. "If the government takes all or nearly all of one's disposable income or surplus income, it must undertake the responsibility for spending it, and it must then support all those works of charity and mercy and all the educational and religious works which in this country have heretofore been supported by private benevolence," the Post said.9

In another editorial, the Post used the Red Cross to underscore its point. The organization had recently sought, and received, donations of $100 million to support its wartime work. "If the money thus contributed were subject to taxes it would be a penalty upon generosity and an inducement for the retention by individuals of all moneys which they formerly contributed to charitable, scientific and educational institutions," the paper wrote. Eventually and inevitably, "the burden of maintaining such national auxiliaries as the Red Cross would fall entirely upon the Federal Government," according to the Post.10

Such arguments took a distinctly benign view of charitable organizations, but not everyone felt so kindly toward exempt organizations. Indeed, suspicion about the social influence of various charities had surrounded their exemption from early income taxes (that exemption having predated the deduction for charitable contributions by several years).11

Laws creating the corporate excise tax of 1909 and the corporate income tax of 1913 both included explicit exemptions for charities.12 The provisions had been readily approved by lawmakers. But they were not universally embraced. Critics of big business saw private foundations -- and many other charitable organizations -- as disguised extensions of plutocratic power. In 1916, for instance, the congressionally chartered Commission of Industrial Relations issued a report sharply critical of both private foundations and private educational institutions:

    The domination by the men in whose hands the final control of a large part of American industry rests is not limited to their employees, but is being rapidly extended to control the education and "social service" of the Nation.

    This control is being extended largely through the creation of enormous privately managed funds for indefinite purposes, hereinafter designated "foundations," by the endowment of colleges and universities, by the creation of funds for the pensioning of teachers, by the contributions to private charities, as well as through controlling or influencing the public press.13

Such worries were not powerful enough to derail the drive for charity tax preferences. And they seemed to disappear almost entirely -- if not permanently -- once the United States entered World War I. The tax exemption for charitable organizations -- defined with notable and growing broadness over the years -- never again saw a serious challenge. Nor, for that matter, did the deduction for charitable contributions.

It seems, then, that if World War I made the world safe for democracy, it also made the tax laws safe for philanthropy.


1 Ellen P. Aprill, "Churches, Politics, and the Charitable Contribution Deduction," Boston College L. Rev. 843, 848 (July 2001). On the 1913 effort, see J. S. Seidman, Seidman's Legislative History of the Federal Income Tax Laws, 1938-1861 944-945 (1938).

2 War Revenue Act, ch. 63, section 1201(2) (1917).

3 See Aprill, supra note 1, at 849.

4 Id.

5 "'The Conscription of Wealth,'" The New York Times, Aug. 24, 1917, at 6.

6 Id.

7 Id.

8 "Exempting Charity," The Washington Post, Aug. 25, 1917, 6.

9 Id.

10 "Charity Exempted," The Washington Post, Sept. 10, 1917, at 6.

11 Kenneth Liles and Cynthia Blum, "Development of the Federal Tax Treatment of Charities: A Prelude to the Tax Reform Act of 1969," L. & Contemp. Prob. 6, 25 (Autumn 1975).

12 Id. at 7.

13 Commission of Industrial Relations, Final Report and Testimony on Industrial Relations, S. Doc. No. 415 (1916), at 81.