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Subsidy by Deduction

25.22. If gifts are deductible from income for tax purposes, the government in effect reimburses the donor for a larger share of the gift the higher the donor's income, and this may be thought vertically inequitable, even though the donor does not reap any personal material benefit from the making of the gift. A tax credit would overcome any suggested inequity between taxpayers, but there is no empirical evidence to show at what percentage rate the credit would have to be set if the present incentive effect of deductibility were not to be reduced for high-income donors. If the percentage were put at 67, the incentive to the top marginal rate taxpayer would be unchanged, lower marginal rate taxpayers would have greater tax incentive, and there would be an increase in the total subsidy. If the percentage were put at a figure lower than 67, some higher rate taxpayers would have less tax incentive to give, some lower rate taxpayers would have more, but the outcome for total contributions to charity, and the resulting total subsidy, would be difficult to estimate.

25.23. In the United States it has recently been proposed by some that, in place of the allowing of deductions to the donor, there should be a matching subsidy from


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public funds equal to the whole or part of the donor's gift, the subsidy going directly to the charity. This would be similar in principle to the United Kingdom system, but would have a wider operation. Under a deduction system, as already explained, a donor on a 60 per cent marginal rate who makes a gift of $100 in effect gives $40 to the charity himself and acts as agent in the giving of a further $60 from public funds. If the allowable deduction were withdrawn, the donor would presumably still be prepared to give $40; and in that he might give more than $40, say $50 or $60, the government grant to the charity could be reduced to $50 or $40 to produce the same yield to the charity. Surveys in the United States of the effect on donors of replacing deductibility by government grants have produced varying evidence, the point being to determine by how much of the tax subsidy the donor would reduce his gift in the absence of the subsidy. The donor might feel less secure about the direct grant than he does about the tax subsidy, and this factor, together with a fear of more government intervention, would affect the extent to which donors would reduce contributions in the changed circumstances envisaged. It should be borne in mind too that whenever a donor contributes, the charity receives the gift there and then. With pay-as-you-earn and deductibility, the donor waits until he is assessed before getting the subsidy, whereas under a direct grant system the charity must wait to receive the grant. The possibly greater administrative costs of a direct grant system over a deduction system must also be considered.

25.24. Similar considerations bear on the question of whether the exemptions of gifts from the gift and estate duties are appropriate ways of subsidising charities.

25.25. In summary, a change from the present deduction system to a rebate system would overcome the objection by some to the deduction system that it is vertically inequitable. A change to a direct grant system would not only overcome this objection but could give government much greater flexibility in settling the amounts of subsidies going to particular charities. However, any change is likely to involve a smaller subsidy than at present in the case of a gift by a high-income or large-fortune taxpayer, and he will thus have less encouragement to make gifts. And it is fair to assume that these taxpayers are the principal source of donations.

25.26. The objection in terms of vertical equity is, in the Committee's view, not a strong one, because a donor cannot be said to obtain a personal material benefit from the making of a gift. And the lesser flexibility in setting amounts of subsidies which a deduction system involves compared with a direct grant system may be seen as offset by the greater encouragement to make gifts which a deduction system may involve. Until empirical evidence is forthcoming showing how far a change would encourage or discourage the making of gifts, the Committee believes that the present deduction system should be retained.

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