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Breaking News: Price rises reduce demand

Michael Sanders

Third Sector Online[1] is reporting the results of a survey by website easyfundraising.co.uk, finding that of 400 people surveyed, some 53% would not give more money to charity if the government were to cut income tax.

Although such a cut is not currently on the cards (although proposals to significantly increase personal allowances over the course of this parliament, if implemented, would reduce the marginal rate of taxation for some and the average rate for most), this finding is interesting (I will ignore for now questions of selection bias raised in TSO’s comment section).

Gary Thompson, the managing director of easyfundraising.co.uk, identifies income tax as an “annoyance”, but is reportedly surprised at the finding that only 47% of the population would choose to spend their windfall on charitable donations, suggesting that: “As a result of the increasing cost of living in Britain, many are facing a difficult time financially, and the coalition government’s public sector cuts and changes to family benefits are clearly having a growing impact on our finances and ability to support charitable causes.”

A lack of financial stability and rising prices are pertinent factors, but even were they not, this result should not be as surprising as it made out.

If income tax were cut, there would be two primary effects. First would be a rise in income; if, let us say, the basic rate of tax were decreased from 20% to 18%, workers would have more money in their pay packet each month. The expected effect of this rise in income would be that individuals may consume more of a variety of goods[2], including, potentially, charitable donations; it is the absence of this effect which is causing surprise here.

However, there is a second effect to consider here. All giving by taxpayers in the UK is eligible for Gift-Aid, whereby charities can reclaim income tax at the basic rate. Hence, the price of giving changes with the income tax rate. At the moment, if a worker wishes the charity to receive £1, she must sacrifice 80 pence of other goods; if income tax fell to 18pence, her donation would have to rise to 82p for the charity to receive the same amount. She will be paying more for the same amount of “good” done. If, as seems likely, tax incentives like Gift Aid make giving more attractive, this rise in the price of giving will make it less, and will lead to a fall in donations.

The results of the survey suggest that for 53% of the population, the price elasticity of demand for donations is larger than the income elasticity of demand; not a damning critique of society or the times we live in.

[1] http://www.thirdsector.co.uk/news/Article/1080657/half-people-not-give-charity-paid-less-income-tax-survey-finds/

[2] If this money is financed from borrowing (as seems likely in the current state of nature), and Ricardian equivalence, a controversial but not disproven theory, holds, then any rise in income will be perfectly offset by a rise in savings as workers seek to cover themselves against future tax rises to repay the debt.

  1. July 25, 2011 at 5:16 pm

    I suppose whether or not they’d answer a survey in that way would be conditional on them making that kind of calculation, but the realisation of their behaviour wouldn’t require them to be calculating, just for them to notice the price. There’s been some discussion about this here today, and the conclusion from some has been that there is no ‘income’ effect, as a rise in income (leading to a shift to the right of consumers’ budget constraints), suggests that their ability to consume all goods should have increased in proportion to their rise in income. What we’d actually see in this case is a pivoting of the budget constraint, because an individual can buy more of everything other than tax efficient things, such as pensions or charitable giving, which are fixed.
    Crudely, if we imagine the world as having two goods ‘donation’ and ‘everything else’, a fall in income tax behaves like a fall in the price of everything else (which, relative to charitable giving, is the case here). Choosing to buy more of something when its price goes down (and correspondingly less of other goods), doesn’t hinge on particularly strong assumptions about rationality.

    One thing I didn’t mention in the original post is that if a fall in income tax is funded by cuts to public services (rather than borrowing), and we believe that charities are substitutes for those services (which sounds plausible in some cases), the utility ‘return’ to donation may rise, potentially prompting a rise in donations. This, however, seems to hinge on a rather stronger assumption of rationality.

  2. Andrew Wray (RED, Bristol)
    July 25, 2011 at 11:37 am

    Does the second effect rely on members of the public thinking through the arguments in this way. They need to be sufficiently interested and motivated to make the calculation above (yet many members of the public can’t manipulate percentages). And they then need to act rationally to respond in the way you’ve suggested.

    I would think that most people are neither sufficiently motivated or rational for the second effect to occur.

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