Governments can use policy tools that give an economic benefit to a favored group, not just by appropriating money but also by exempting an event or a transaction from taxation. This way, such tools can allocate benefits and have several advantages as it will not further burden the government’s budget and can also reduce the apparent burden of taxation on individuals. But economists have been quick to point out that the economic effect of such deductions can be equivalent to an appropriation of public funds, both from the point of view of the government, which is deprived of that portion of receipts from taxation, and from the point of view of the taxpayer, who is allowed to retain funds that would otherwise be taxed (Yarmolinsky, 2000).
Charitable deductions permit certain taxpayers to deduct their contributions to charitable, educational, and scientific organizations in calculating their taxable income. From the perspective of the government, allowing for charitable deductions can be seen as a carrot, to incentivize people to give to certain kinds of charities that may have positive externalities. As noted by Brody and Cordes (2006), the most visible way in which the federal government acts as a benefactor of nonprofit sector is by allowing individuals and corporations an income tax deduction for the value of their charitable contributions. These deductions can be viewed as providing an important economic incentive for private donors to provide financial support to a wide range of philanthropic enterprises. It can also have a direct effect of freeing the government from having to perform the same service, which can thereby be seen as the government subsidizing itself. The public service performed by the contribution may be something that 9 government could not have done given the lack of either the means or the will to do it and could remain untended if a charitable initiative did not intervene.
Within Hood’s NATO taxonomy, charitable deductions can be seen as a ‘Treasure’ resource used by the government to set the agenda by using its authority while deciding what kinds of activities should be indirectly supported by giving tax-exempt status and how citizens can be incentivized to support certain kinds of programs that have positive externalities. They forego taxes to their treasury in exchange for some activity they think is good and would like to promote.
Brody, Evelyn and Joseph J. Cordes, “Tax Treatment of Nonprofit Organizations: A Two-Edged Sword?” in Boris, Elizabeth and C. Eugene Steuerle (Eds.), Nonprofits and Government, 2006, pp. 141-181. Urban Institute Press, Washington, DC.
Yarmolinsky, Adam, “The Charitable Deduction: Subsidy or Limitation?” Nonprofit and Voluntary Sector Quarterly, 29, 2000, pp. 173-178.