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Posts Tagged ‘Tax Incentives’

“The rich are different…“

April 18, 2012 3 comments

Sarah Smith

The furore over the cap on tax relief on charitable giving refuses to go away. As one back bencher put it the other day – it is hard to see why you would want to pick such a fight for such small estimated financial savings.

And if you do, it would be good to be armed with some good arguments and some hard evidence – the current Government appears to have neither.

The bad arguments are that wealthy philanthropists are dodging tax to give to dodgy charities. The overwhelming majority of philanthropists most likely are not – and anyway, a tax cap is the wrong tool to address the problem.

A better argument would focus on the effect of tax incentives on donations. If you cut tax incentives, donors are likely to reduce their giving (i.e. the charity sector will lose) but they aren’t likely to stop giving altogether. The critical issue for the Government is whether the loss in donations is more or less than the gain in tax revenue. It is the combination of the two – total donations and total tax revenues – that will determine the overall level of “public services” (in the broad sense) that can be provided.

What matters is the responsiveness of charitable donations to changes in the “price of giving”. The critical level of the price elasticity is one (in absolute value). If the price elasticity is less than one in absolute value then the fall in money from donations will be less than the increase in Exchequer revenue – the charity sector will lose but this will more than offset by an increase in tax revenue out of which to fund public services (or to compensate charities). If the price elasticity is greater than one in absolute value, however, then the fall in donations will be greater than the increase in tax revenue.

What does the evidence say? The Government has said very little on the likely behavioural response. But just over two years ago, we did some research for HMRC and HM Treasury on donor responsiveness to changes in Gift Aid tax relief. This looked at both the rebate relief (how much higher-rate donors can claim back – which is the bit that is going to be capped) and also the basic-rate relief that charities can claim on all taxpayer donations. This second element is a bit like a match – I give £1 to charity out of my net-of-tax income and then the Government matches it with 25 pence worth of basic rate relief. Our main finding for higher-rate taxpayers as a whole was that contributions were significantly more responsive to changes in the match element (elasticity greater than one) than they were to changes in the rebate (elasticity less than one) – this result is shown in the first row of the table below.

In principle, this would provide a plausible rationale for cutting back on rebates. An elasticity less than one in absolute value means that rebates are not a cost-effective way of increasing money going to the sector – it would be more cost-effective for the Government to increase the match element, or to allocate the funding to charities itself through grants.

Yet, as F Scott Fitzgerald once said, “the rich are different to you and me” and in this case, the more people give, the more responsive they are to changes in tax relief – not surprisingly since the stakes are higher. This is clear from the other results in the table below. In the report, we estimated the elasticity separately for donors who had given £10,000 a year or more – and found that they were more responsive than other higher-rate donors, although the rebate elasticity was still below its critical level.

But, we can do further analysis on the data to get closer to the group that is actually going to be affected by the cap. The table reports new results for donors who reported that they gave £25,000 and £50,000. The sample sizes are small for this final group, but the estimated rebate elasticity is -1.19. This is greater than the critical level, implying that the loss in donations following a cut in the rebate would be greater than any increase in tax revenue.

Of course, there are caveats to this finding  – donors were responding to hypothetical changes, there are only a few really big donors in the sample, a cap on relief is not the same as a change in the value of the rebate. Yet, it is pretty much the only available evidence on how these donors would respond and it suggests a sizeable response among the group that is going to be hit by the cap – bigger than any increase in tax revenues.

Estimated elasticities – changes to the rebate and match elements of Gift Aid.

Donations

Rebate elasticity

Match elasticity

p-value

N

All higher rate donors

-0.33

-1.16

0.000

850

Donations >=£10,000

-0.64

-1.19

0.000

83

Donations >= £25,000

-0.72

-1.28

0.018

30

Donations >=£50,000

-1.19

-1.93

0.045

12

p-value is for test of equality of rebate and match elasticiites. Source: Analysis of online survey responses – Justgiving donors and CAF account holders.

The impact on the level of funding, therefore, is potentially negative. There may be a different argument to be made about the allocation of funding – the services funded through private donations will be different to publicly-funded services. In some quarters, this has been characterized as a choice between the NHS and the Royal Opera House, although this is a gross simplification – wealthy donors give to a range of different charities; and charities may be better at delivering public services in many cases. Indeed, one reason why the cap on tax relief is hard for many to swallow is that up until now, this Government has been clearly signaling that it favours private funding  and private delivery (“Big Society, not Big Government”). Behind the debate over the tax cap lie some fairly fundamental issues about how – and by whom – public services should be funded and provided.

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Charitable Giving – How hard can it be?

Michael Sanders

Jeremy Clarkson, of Top Gear fame (among other things), made use of his column in this Sunday’s News Review[1] (in the Sunday Times, paywalled), to bemoan the death of philanthropy, and to propose a surprisingly economist-friendly explanation; the arrival of substitutes.

As Mr Clarkson says, “it’s because in the days of (William) Morris, and my great-granddad there wasn’t much you could actually buy”. Certainly it is true that since the 1930s the sheer number of status symbols required to maintain the kind of upper-middle-class lifestyle expected of a Times columnist has increased dramatically, and it is also true that charitable giving is, for many parts of society, on the decline[2]. That people, when given the choice between buying mosquito nets for others half way around the world or a new iPad for themselves, choose the iPad, seems intuitively simple. It is also on sound footing economically; if a preferred substitute comes along, from which you extract greater utility, substituting from one into another is only natural, and as the relative price of the substitute declines (as is typical for technology), we might expect the level of this substitution to increase.

Governments of all stripes appear to have agreed with this basic assessment, with the last Labour government reducing the ‘price’ of giving by making Gift Aid, a tax-efficient means of giving, available on donations of all sizes (previously it was available only on donations of £250 of more), and the current, coalition government, aiming to increase the ‘return’ on giving through rises in the Gift Aid Benefit Limit to “enable charities to give ‘thank you’ gifts”[3].

If all this seems sensible, what can we say about the conclusion to the article, that for Philanthropists, “their investment is going to make them a damn sight happier than the man who spent his cash…” on something more frivolous. Traditional economic theory suggests that this should not be the case. Following the Weak Axiom of Revealed Preference (WARP), if an individual chooses to buy a grande skimmed-milk extra shot mocha rather than mosquito nets, we can conclude that he prefers, given his income constraints, coffee to mosquito nets. Simplistically, this situation appears to be Pareto optimal – it is impossible to make one party (those at risk of mosquito-borne-disease) better off, without worsening the lot of another (our coffee drinker). Although it is possible to make a moral argument for redistribution from coffee to mosquito nets to improve social welfare, we might expect Clarkson’s pleading with us to give more to charity to fall upon deaf ears.

Some insight into why a narrow view of economics might seem to be wrong, and the Sunday Times’ most controversial columnist might be right, can be found in Behavioural Economics. A large quantity of research, summarized by Dellavigna (2009)[4] and Bernheim & Rangel (1995)[5], suggests that individuals may make decisions which are not only socially undesirable, but personally undesirable as well.

While changes in the relative price or value of giving may increase individuals giving, it is, of course, costly to do so, and will be less effective than governments might hope if, as the literature suggests, would-be donors are inattentive to the benefits of giving, or to the changes in policy.

In the coffee vs nets example, we can see another reason for the government to explore in depth the lessons of behavioural economics when planning the “Big Society” – these lessons are already being learned, and to great effect, by the firms with which charities are competing for funds. The placement of biscotti, mints and caramel waffles near the till in coffee shops, the offer made by baristas or their local equivalent (“would you like to go large on that?”), and defaulting to a mid-sized cups, are all Nudges; examples of behavioural economics put into practice.

It is clear that if the government is to achieve a ‘step change’ in the level of giving in the UK, and in so doing make both donors and recipients happier, charities will need the tools to compete with private firms and the willingness to use them – behavioural economics has the potential to offer those tools, and they are already being used to great effect by the competition.


[2] Smith et al (2011): “The State of Donation” Centre for giving and philanthropy.

[3] HM Treasury (2011) “Budget 2011” HM Treasury, HC836

[4] Dellavigna (2009): “Psychology and Economics: Evidence from the Field” Journal of Economic Literature Vol 47 No 2 pp315-372

[5] Bernheim & Rangel (1995): “Behavioural Public Economics: Welfare Policy Analysis with Non-Standard Decision Makers” NBER Working Paper 11518

3 million will face punitive tax rates under Universal Credit

Paul Gregg

 

Further details of the new Universal Credit were recently announced, with much fanfare. The plans integrate a number of different benefits and tax credits into one system which will make transitions in and out work administratively easier for claimants. The new system also makes taking mini-jobs (<16 hours) far more attractive, both to those out of work and to those currently working 16 to 20 hours in order to be eligible for the in-work tax credits introduced by Gordon Brown.  When Ian Duncan Smith first discussed the need for reform he also highlighted the very high effective tax rates people face when earning more. We all pay income taxes on extra earnings but tax credits and the new Universal Credit are also withdrawn, leading to high effective tax rates.  The details show what will happen to these effective tax rates under the new system and compares to what it calls the current system.

The current system will apply from April this year, which is important because the new government increased these effective tax rates in their first budget. The table below shows the figures announced today in the final two columns. It shows how the new regime will reduce the numbers of people with effective tax rates over 80%, but increase the numbers facing 70% to 80% tax rates. It will also increase the numbers facing 60-70% tax rates; this is people just on Universal Credit. Overall there is an increase of half a million people facing effective tax rates at 65% or over.

But this excludes the effects of the budget earlier this year and in the first two columns I report the numbers produced by HM Treasury at the time. They are not quite identical for the ‘current’ system for reasons that are not clear. But the point here is that this budget sharply increased the numbers facing tax rates between 70 and 80%, though to be fair this was mostly a move from 70% to 72 or 73%. But the point is that despite earlier statements from Ian Duncan Smith, the numbers facing punitive tax rates will have risen by 300,000 under this government and the normal tax rate for these people will have moved from 70 to 76%. As such the new regime encourages people to work a little bit, but reduces the incentive for people to work more.

Marginal Effective Tax Rates Financial year 2010/11 Financial year 2011/12 Current

 

Projected under Universal Credit (IFS)
80%+ 0.3 0.3 0.7 0
70-80% 0 1.4 1.7 2.0
60-70% 1.6 0.2 0.2 0.9
Under 60%     1.3 0.9

 

 

 

 

 

 

 

 

The season of goodwill

December 21, 2010 Leave a comment

Sarah Smith

Charities might rightly feel that they have had a tough year. First the recession which many charities claim hit their donations. Then, the announcement of public spending cuts which will affect thousands of charities which rely on government funding.

The festive season should therefore bring a brief respite and provide a temporary boost to charity incomes as this is the time of year when people really do dig a little deeper and give more to charity than during the rest of the year. The chart below shows average weekly household donations to charity for each month in the year – there is a spike in march/april, coinciding with the end of the tax year, but a greater spike in December. Santa, it appears, has a greater effect on giving than the tax man. These averages are for households that actually give to charity; the proportion of households who give is also slightly higher in December than at other times of year, but it is the amounts that people give that show the biggest increase at Christmas. The average weekly amount given is nearly £12 in December – more than twice the average amount over the preceding three months.

Source: Living Costs and Food Survey, 2008

It is hard to say exactly what accounts for the festive increase – other than it being the season of goodwill to all men. Some of it may be religiously motivated; the evidence shows that religion is strongly associated with charitable giving and that people who are religious are more likely to give to charity and to give more. Yet as religiosity has declined in the UK over the past thirty years, Christmas giving has remained high and, if anything ,has increased over time. In 2008 (which is the latest year for which we have data) giving in December was 60 per cent higher than the average over the rest of the year; thirty years ago (over the decade 1978-88) it was roughly 16 per cent higher.

As part of the Big Society, the government is keen to encourage charitable giving. Research that we carried out on behalf of HM Treasury showed that tax incentives are not particularly effective at encouraging people to give more. The majority of people do not respond to changes in tax incentives by changing how much they give, although this does mean that Gift Aid style incentives that allow the charities to claim back the tax paid on donations can help to boost charities incomes (more than rebate-style incentives which rely on donors to adjust their giving). Understanding the December effect could give insights into what motivates people to give and be used to design more effective policies. As charities enter 2011 facing up to the reality of cutbacks in public spending both they and the government will be keen to ensure that higher giving is not just for Christmas.