If you plan on doing a bit of charitable giving this holiday season and enjoy the tax deductions that come with it, listen up. As we head toward the fiscal cliff, Congress might make changes to the charitable tax deduction to increase revenue. But where did the tax deduction come from in the first place and could changes help the middle class?
The history of the charitable tax deduction can be traced all the way back to World War I, when the federal government, desperate for revenue to fund the war, began taxing the rich at incredibly high rates -- the highest being 77 percent. At that time, income taxes were paid by the top 4 or 5 percent of earners. However, with spiking tax rates, there was worry in Washington that those earners would stop giving to charities. And so, according to tax historian Joe Thorndike, the charitable tax deduction was born.
"The theory being that, especially rich people, who are paying a lot of tax on that last dollar of income will be motivated to give more if they can save money on their taxes," says Thorndike.
Thorndike, who wrote the book "Fair Share: Taxing the Rich in the Age of FDR," says the deduction was designed to benefit the rich because they were the ones paying income taxes at the time.
Fast forward to World War II: during that time, the government, again looking to grow revenue, broadened the tax base. As a result, more people paid income taxes and more people -- in theory -- had access to the charitable tax deduction. But, the deduction, originally created for the rich, remained designed to pay off more for high earners -- and so it remains today.
"If you're well off and in the 35 percent tax bracket and give $1,000 to the Red Cross -- you're going to get a $350 tax break on that gift. But if you make less, and you're in the 25 percent tax bracket -- you'll only get a $250 dollars tax break on that $1,000 donation to the Red Cross," explains Marketplace Wealth and Poverty reporter Shereen Marisol Meraji.
With the fiscal cliff negotiations at the forefront of Washinton's agenda, economists are starting to wonder if it makes sense for a heavily in-debt federal government to subsidize donations from the rich more than the middle class. Instead, some are proposing lowering the subsidy for giving, thereby saving the goverment money, and making the subsidy equal for everyone. It seems like a win-win, but charities fear donations will decrease if the goverment lowers the deduction.
"At a time when we should be encouraging everyone to give to help the poor, we seem to be experimenting with a disincentive," says John Ashmen, president of the Association of Gospel Rescue Missions.
As of now, nothing has been done to change the charitable tax deduction and Americans can still take advantage of it on their 2012 taxes. But, 2013 -- that could be a different story.