NYU School of Law
Conference on the Privatization of Development Assistance
Tax Aspects of Private Development Assistance
Eric M. Zolt
Michael H. Schill Professor of Law
UCLA School of Law
Policy Question
• If have $50 billion in U.S. government funds available each
year to support charitable activities, how should those funds
be used?
Efficiency Concerns
• Encourage activities with the greatest social returns. Compare costs of lost
tax revenue with benefits from gains from charitable activity
– Worthiness of purpose
– Efficiency in performance
• Behavioral effects—target tax incentives to increase the level of marginal
giving
– Little to gain for providing tax benefits to those who would give anyhow
• Compare tax expenditures for charitable contributions with other uses of
tax revenues to achieve similar or other objectives (including lower taxes)
• Types of tax benefit—compare use of the charitable tax deduction with
other tax instruments (e.g. targeted credits) that may encourage the level
of charitable activities
Fairness Concerns
• Who decides how funds should be spent?
– Alternatives
•
•
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Government bureaucracy
Band of experts
Equal votes among citizens
Greater voice to those taxpayers who give more (“Upsidedown subsidy”)
– Tensions
• Value of democratic accountability in the use of public
resources
• Value of engaging private actors in increasing the level of
collective goods and services
Key Questions
• Should tax benefits support charitable activities outside the
United States?
• Should the tax system treat foreign charities differently from
domestic charities?
• Should the tax system extend tax benefits to for-profit
charities, including foreign entities?
Tentative Conclusions
• Cannot meaningfully distinguish among types of activities
without some type of framework for determining comparative
worthiness
• Questions cannot be answered by simply looking at existing
theories justifying tax deductions for charitable activities and
determining whether there is an adequate basis for
distinguish between types of activities or providers
– Between domestic charitable activities and foreign charitable activates
– Between domestic charities and foreign charities
– Between non-profit charities and for-profit charities
U.S. Tax Provisions Governing
Charitable Activities
• Exemption from federal income tax
• Eligibility to receive tax-deductible charitable contributions
– Income tax deductions
– Gift and estate tax deductions
• Access to tax-exempt financing
• State and local income, sales, and property tax benefits
Restrictions on Funding Foreign Charitable
Activities
• Place of organization restrictions
– Donee must be “created or organized in the US or in any
possession thereof….” Section 170 (c)(2)(A)
• Place of use restrictions
– Few limitations for use of funds outside the US by domestic
charities
– Corporate donor limitations
• Foreign recipient must be corporation, not a trust,
partnership
• Limitations for determining foreign source income for
foreign tax credit limitations
– Private foundation restrictions for grants to foreign grantees
Distribution of Federal Income Tax Burden
Question 1: Charitable Deductions for Foreign
Charitable Activities
• Judge Richard Posner blogs against allowing U.S. taxpayers to claim
tax deductions for gifts to domestic charities that donate or operate
abroad. His opposition does not rest on the grounds of
– U.S. government foreign aid projects more efficient than private
activities
– Nor challenge the external benefits of charitable deductions in
overcoming free-rider problems
• Posner contends that denying deductions for foreign charitable
activities will:
– Increase funds available for domestic charitable activates
(“substitution effect”)
– Decrease the level of the overall subsidy for charitable activities
(“revenue effect”)
– Greater utility for domestic giving as foreign charitable activities
reduce the pressure for political, economic and social reforms
(“Mugabe effect”)
Insights from Tax Scholarship
• Donor focused theories; Income measurement
– Andrews:
• Not acts of personal consumption—no “private
preclusive use”
• Create common goods “whose enjoyment is not
confined to contributors nor apportioned among
contributors according to amounts of contributions”
– Bittker
• Equitably accounts for loss of welfare by donor
• Donations derive from perceived moral obligations
• Rewards selfless acts
Subsidy Theories
•
Treasury efficiency
– Tax subsidies encourage the private sector to fund activities that might otherwise
have to be financed with public funds
• Gains from additional contributions greater than lost revenue
• Gains from additional contributions as compared to alternative uses of lost revenue
•
Market failures
– Level of public goods and services (non-rival, non-excludable) undersupplied as
rational self-interested individuals will choose to free ride on the charitable activities
of others
– Most goods and services provided by governments (or charities) are rival and
excludable—but they can generate positive externalities not captured by market
participants
•
Government failures
– If leave spending decisions solely to political process, then the level of collective goods
and services decided by majority rule
– Tax subsidy allows a minority of taxpayers to receive government support as long as
they are willing also to contribute to the cost
– Decentralized approach allows for greater diversity, innovation and other benefits
Application of Subsidy Theories to
Foreign Charitable Activities
•
Theories do not provide a basis for distinguishing between
domestic and foreign charitable activities
–
–
•
Greater government and market failure in developing countries
Theories provide little guidance as to which types of activities to support, how
much, and within which countries.
Failure to address issues in cross-border activity
–
–
Assumes single society: preferences of majority trumping interests of the
minority; but not consider interests of other groups
Assumes three sector society: U.S.-centric view of government, private sector,
and non-profit sector; larger group of actors in developing countries
Question 2: Charitable Deductions for Foreign
Charities
•
Statutory restrictions and legislative history
•
Consequences of extending tax benefits to foreign
charities
•
Enforcement and compliance concerns
•
Implementation alternatives
Legislative History of
Revenue Act of 1938
• The exemption from taxation of money or property devoted
to charitable or other purposes is based upon the theory that
the Government is compensated for the loss of revenue by its
relief from financial burdens which would otherwise have to
be met by appropriations from public funds and by benefits
resulting from the promotion of general welfare. The United
States derives no such benefit from gifts to foreign
institutions, and the proposed limitation is consistent with
the above theory. (HR Rep. No. 75-1860, at 19-20 (1938).
Consequences of Extending
Full Tax Benefits to Foreign Charitable Activities
and Foreign Charities
•
•
Effects on quantity and quality
–
Recruit private monitors
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Access to information, lower operating expenses
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Political challenges and corruption issues
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Support development of non-profit sector in developing countries
Interaction with other providers
–
•
Supplementary , complementary, or adversarial
Substitution away from domestic charities
–
Domestic charities engaged in domestic activities
–
Domestic charities engaged in foreign activities
Enforcement and Compliance Concerns
•
Section 170 requires contributions to be used exclusively for
charitable purposes and no private inurnment
– Important to have a U.S. intermediary, especially where
the IRS lacks the ability or authority to audit activities
outside the U.S.
• Added oversight concerns in post-September 11, 2001 world
• Little effective private monitoring of cross-border charitable
activities
Implementation Alternatives if Allow Foreign
Charities
• Application process
– Allow foreign charities to apply not only for “taxexempt” status but also the right to receive tax
deductible contributions
• Approved charity list
– Canadian and Irish approach of allowing deductions to
listed charities
• Approved country list
– Substantial equivalency regimes
• Expand treaty provisions
– Current treaties with Canada, Israel and Mexico allow
US residents to reduce foreign source income by
Question 3: Charitable Deductions for
Contributions to For-profit Charities
• Theory
– Gap in providing essential collective goods
– Non-profits not the only (or even the best) game in town
• Malani and Posner
– Existing theories do not provide adequate rationale for denying tax benefits to
for-profit charities
– Can “contract away” non-distribution constraint for all or a part of profits from
activities
– Real efficiency gains from cost-minimization and incentives for managers
• Critiques
– Can eliminate inefficiencies with more limited proposal (Kane)
– Costs and challenges of compliance and monitoring
– May need to redefine tax-exempt activities in for-profit charity regime
Logic of Malani and Posner
•
Basic approach
1. The leading theories for allowing tax-deductible charitable contributions are A,
B, and C;
2. Theories A, B, and C do not distinguish based on for-profit and non-profit
status;
3. Therefore, the leading theories do not provide a basis for distinguishing
between for-profit and non-profit charities; and
4. Therefore, we should allow deductions for contributions made to for-profit
charities
•
Two possible outcomes
1. Leading theories provide adequate justification for charitable deduction (1 and
2 are true and support conclusions 3 and 4)
2. Leading theories do not provide adequate justification for charitable deduction
(1 and 2 are true, provides support for conclusion 3 but not necessarily for
conclusion 4)
For-profit Charities
Potential gains
• Include social enterprise or
fourth sector organizations in
group of potential donees
• Increase pool of potential
providers of collective goods
and services
– Increased competition for
contributions may lead to
more efficient operations
– Greater diversity
• Incentive gains from rewarding
entrepreneurial managers
Potential challenges
• Potential for abuse
– Scope of “charitable
purpose” may take a
broader meaning than
generally accepted in a
“non-distribution” world
– Potential transfer-pricing
concerns between related
entities engaged in
charitable and noncharitable activities
– Monitoring costs
Alternatives for Increasing
For-profit Charitable Activities
• Targeted credits
• Public/private partnerships
• Matching grants for specific activities
• Awards and prizes