J Cult Econ (2008) 32:293–300 DOI 10.1007/s10824-008-9083-x ORIGINAL ARTICLE

Who pays? Who benefits? Who decides? Michael Rushton

Received: 16 October 2008 / Accepted: 16 October 2008 / Published online: 11 November 2008
Springer Science+Business Media, LLC. 2008

Abstract This paper was presented at the symposium dedicated to the 25th anniversary of the publication of Patrons Despite Themselves: Taxpayers and Arts Policy (Feld et al. 1983), held by the Association for Cultural Economics International, Boston, June 2008. It considers alternative means of providing indirect taxbased state support of the arts, such as the use of tax credits as opposed to tax deductions for charitable contributions, matching grants, and support applied to specific projects. It also considers the problem of broad-based changes to tax policy that have unintended consequences for arts organizations. Keywords

Tax expenditures
Public funding for the arts

JEL Classifications

H24
Z11

This panel discussion was Mark Schuster’s idea; he thought it would be worthwhile to bring together the co-authors of Patrons Despite Themselves (PDT) (Feld et al. 1983) and present a retrospective on the book, its origins, impact, and implications for future research. He was going to be a presenter on this panel, and it saddens me greatly that he cannot be here. In the discussions we had last year, we talked about how the three co-authors might allocate their attention. In this segment of the panel, I am going to try to address the topics that Mark told me he wanted to talk about himself, and I will use some of his more recent research articles as my guide to how his thinking evolved.

M. Rushton (&) School of Public and Environmental Affairs, Indiana University, Bloomington, USA e-mail: [email protected]

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1 American exceptionalism It is worth remembering at the outset that PDT is a book focused on an exceptional system for public support of the arts, a system of tax expenditures, with the tax deductibility of charitable donations to nonprofit cultural organizations as its centerpiece, that radically decentralizes the allocation decision, and that, at the federal government level, consists of a level of support well over 10 times the amount of direct federal support through the NEA (Brooks 2004; also see Schuster 2006, p. 1263, for analysis of the Brooks estimates). Mark has noted that European governments have also long used tax incentives in the arts (Schuster 1986), but the ‘‘take-up’’ rate of the tax deduction has been far greater in the United States than in Europe. Cowen (2006) calls indirect subsidies the ‘‘genius’’ of the American system, and Weil (1991) reminds us that it allows indirect public funding of difficult and controversial art for which the general populace would not support direct funding (also see Schuster 1999, pp. 77–78). While some might cheer this outcome, another way of looking at it would be to say that this significant tax expenditure for the arts lacks accountability, something captured by the title of PDT. Drawbacks (according to taste) of the American system are that it allows the rich to have a disproportionate say in how public support is allocated, that arts organizations will skew their activities to those that have most appeal for wealthy donors (PDT, pp. 133–145, notes that museums will be biased towards new construction and to stored art), and that it fosters ‘‘nonprofitism’’ (Weil 1991; Ivey 2008)—funding is directed at established nonprofit organizations rather than individual artists or small, start-up commercial enterprises in the arts. Note that the basic deduction for charitable contributions to any nonprofit arts organization is not the only way to organize indirect support. In particular, it is possible to design policies that are more targeted. For example, instead of indirect support being automatic, a tax credit might be given for a donation to an arts organization if the funded project passes a state approval process (Chile), or the state might limit those organizations for which donations generate a tax deduction to those that have been approved by appropriate government agencies (Australia), or earnings from designated arts activities might receive special tax treatment (Ireland); these examples are discussed in depth by Schuster (1999, 2006). A new and perhaps surprising finding in PDT concerns the redistribution that occurs through tax expenditures in the arts and programs offered by arts organizations. Asked to make a guess, there might be many people who would hazard that this redistribution must be regressive—are the rich not the primary beneficiaries of the nonprofit arts? Mark expressed surprise (Schuster 2006, p. 1281) that arts organizations had not done more to publicize the finding that the tax expenditure for donations to the arts, combined with consumption patterns, is not regressive (although neither is it strongly progressive): …on the average, subsidies to the arts, including those financed through the tax system, flow from the very wealthy to the moderately wealthy and the

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well-educated. Notwithstanding the stated goals of government support, such as, for example, through the National Endowment for the Arts, poor and moderate-income people apparently do not benefit much. (PDT, p. 71) Some later work confirmed the PDT findings: Netzer (1992, p. 202) found that ‘‘the frequent allegation that support of the subsector from tax funds and taxdeductible gifts is a transfer from those in the middle of the income distribution to those at the top of the distribution is a caricature,’’ and Schuster (2006) maintains that no evidence has been generated contrary to the incidence analysis of PDT (see also Cordes (2004) on the incidence of indirect support across types of nonprofit arts organizations).

2 Tax incentives and tax reform PDT contained the following warning: Many artists and arts institution administrators, as well as donors and members of the general public, think that insulating government support from political change is necessary to safeguard artists, their works, and arts programs from intervention and intimidation. Many arts professionals believe that the indirect government aid system ensures that bumptious lawmakers and bureaucrats can neither dictate art institutions’ policies nor impose artistic views on them. Unfortunately, the security of indirect government aid is not as dependable as many of its proponents seem to believe. Unlike direct grant assistance, indirect aid is vulnerable to modifications in the tax code that sometimes are related only peripherally to arts and other charitable institutions. (pp. 179–180) How do changes to the income tax system affect charitable giving? An increase in the income tax rate, other things equal, will affect giving in two ways: it will lower personal disposable income, causing rates of giving to fall, and it will lower the ‘‘tax price’’ of giving (which is one minus the marginal income tax rate), which will cause rates of giving to rise. The consensus of research is that the substitution effect is dominant, so increases in marginal tax rates tend to increase charitable giving. In a survey of the literature, Clotfelter (1985) found a range for the elasticity of charitable giving relative to changes in the tax price of giving of between -1.1 and -1.3. Peloza and Steel (2005) found that when they remove estimates that are more than three standard deviations from the mean, the weighted average of estimates of the elasticity of giving with respect to the tax price is -1.11, within Clotfelter’s range. More recently, using a large panel data set that takes advantage of state-level taxes to help in identifying the effects of changes in federal taxes, and accounting for expectations regarding whether tax changes are temporary or permanent, Bakija and Heim (2008) find a tax-price elasticity of giving, with respect to permanent changes in the tax-price, of -0.7, and a lower elasticity for temporary changes to taxes, consistent with the permanent income hypothesis. Brooks (2007) reminds us that only if the tax-price elasticity of donations is greater than one does the increase in donations generated by the tax deduction exceed the foregone tax

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revenues; if we were indifferent regarding the ‘‘who decides’’ question in arts funding, then if the elasticity of giving is less than one the government can get more money to arts organizations by simply granting them the funds directly rather than indirectly through the tax deductibility of donations. But the key point here is that the marginal tax rate matters in a significant way for contributions to arts and other nonprofit organizations, and that tax rates are typically changed without the effect on charitable contributions being a salient issue. One area of tax policy that could have a major effect on arts organizations in the United States is the estate tax (Rushton forthcoming). The federal estate tax applies to the net value of estates after deducting from the gross value any debts, interspousal transfers, some administrative costs involving the estate, and, most important for our purposes, charitable gifts. Unlike the personal income tax deduction for charitable gifts, there is no maximum amount for the estate tax deduction for charitable gifts. There is a high threshold level for the value of the net estate, below which there is no effective tax. Since 2001, with the Economic Growth and Tax Relief Reconciliation Act (EGTRRA), the threshold net value of the estate above which the estate tax becomes effective gradually has been rising over time, and the tax rates have been falling over time, such that the estate tax becomes fully repealed in 2010. But the Act has a sunset clause, such as that without further action by government the estate tax would revert to its 2001 structure in the year 2011. At the 2001 (and scheduled for 2011) rates, the exemption on the net value of the estate after all deductions is $1 million, and the top statutory rate is 55%. As of 2008 the exemption is at $2 million, and the top marginal tax rate is 45%. In general, estimates hold that the tax-price effect is greater than the wealth effect, such that the estate tax overall encourages charitable bequests (Bakija and Gale 2003; Joulfaian 2000). This is not surprising when we consider the sharply progressive rate structure of the tax. Consider the 2008 rate structure, where the first $2 million of the net value of the estate is exempt and a 45% marginal tax rate applies above that threshold. Then an estate with a net value of $2.5 million has a marginal tax rate of 45% but an average tax rate of just 9%. Changes in the estate tax—for example, repeal of the tax—thus has a much bigger ‘tax price’ impact, which depends on the effective marginal tax rate, than ‘wealth’ impact, which depends on the average tax rate (Bakija and Gale 2003). How large would be the effects of the repeal of the estate tax on charitable giving? McClelland (2004), reconciling estimates by Joulfaian (2000) and Bakija and Gale (2003), develops, what I think, we can safely call a consensus view that elimination of the estate tax would cause a drop in charitable bequests by about 22%. Now as it turns out, neither of the two major-party presidential candidates in 2008 supports the total elimination of the estate tax. Barack Obama has indicated that he would maintain the estate tax at its 2009 rate structure, with a threshold for individual estates of $3.5 million and a marginal tax rate of 45%, and John McCain would set a higher threshold of $10 million and a marginal tax rate of 15% (Policy and Taxation Group 2008). Still, back-of-the-envelope calculations, starting with McClelland’s estimates, suggest the Obama plan would lower charitable bequests by around 5%, and McCain’s by 15% below what would obtain with the 2001 tax structure. If we assume that the tax-price elasticity of charitable bequests to arts

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organizations is not greatly different from the elasticity with respect to all charitable bequests, then this tax change will have a significant effect on donations, and the effect will be entirely in the form of collateral damage.

3 Tax incentives versus matching grants The standard model of charitable donations postulates individual utility as a function of donations, disposable income after taxes and donations, and demographic characteristics, and the solution to optimal giving sets the marginal rate of substitution between giving and private consumption equal to the relevant price ratio. However, this basic model of optimizing behavior takes no account of how the subsidy to charitable giving is implemented. Suppose that instead of a tax deduction for donations, the government promised a matching grant to any nonprofit organization receiving a donation. For example, suppose under regime X charitable donations are tax deductible, and the marginal income tax rate is 1/3. I can make a $1 donation to my favorite charity, and it will cost me 67 cents. Under regime Y there is no charitable tax deduction, but the government makes a grant to any charity to which I donate, in an amount equal to 1/ 2 of whatever I donate. I can give 67 cents to my favorite charity, and the government will give it 33 cents. In the standard way of setting the utility maximization problem, regimes X and Y are equivalent. But are they the same in practice? The first thing to note is that many people are confused by the use of percentages, and might believe that a matching grant of 50% must be larger than a rebate of 33% because 50 is a greater number than 33. So while researchers in experimental settings might make efforts to ensure clarity for the participants, in the real world, there is likely to be at least some confusion. Eckel and Grossman (2006) find that individuals tend to give more under a matching system than under a tax-deductionlike rebate system. For rebates, they find the tax-price elasticity of giving is about -1.2, in line with the research cited above that uses data from the tax system. But they find a much higher elasticity, ?2.6, with respect to matching funds. In a randomized field experiment involving charitable donations to be matched by a ‘leadership donor’, Karlan and List (2007) find that the existence of a match increases the revenue per solicitation (by 19%) and the likelihood of donating (by 22%), but they find that the size of the match does not matter. This finding is reminiscent of the ‘embedding effect’ in contingent valuation studies, where individuals choose an amount they would be willing to give that is independent of the magnitude of the good that the donation is meant to achieve (Diamond and Hausman 1994). But lest we conclude that a state promise to match donated funds might induce more donations than the extant rebate system, Meier (2007) finds that while matching grants initially induce higher donations, when the matching stops donations fall back to a level below their initial pre-matching grant amounts; this is a reminder of the potential negative effects of incentives on giving, dampening our personal motives for generosity.

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4 Tax deductions or tax credits? In the United States, charitable donations are deducted from earnings when formulating the base of the personal income tax, whereas in Canada, for example, charitable donations are not deductible, but are awarded a tax credit, at a percentage of the donation equal to the top marginal tax rate. This was 29% at the federal level in 2007. Canada also has significant provincial personal income taxes, where additional tax credits for charitable donations are available. In my old home of Saskatchewan, to take a typical example, the provincial credit for charitable donations is 15%, giving a total federal-plus-provincial tax credit for charitable contributions of 44%, even for low-income taxpayers who would face a marginal tax rate of much less than 44%. Is it better to have tax deductions or tax credits? PDT (pp. 216–220) noted that a shift from tax deductions to tax credits, keeping the total size of the government tax expenditure the same, would lower the tax-price of giving for lower-income individuals and increase it for higher-income individuals, and this would help in lessening the dominance of rich donors over arts organizations (also see Schuster 1987). That said, PDT also reported that arts organizations would suffer as a result of such a shift in policy, as they do well, relative to other charitable sectors, from wealthy donors. Notwithstanding the likely fall in donations, PDT recommends a shift to a tax credit system, on the grounds of improved equity and pluralism in the system. But the debate is an excellent reminder of the challenges in designing a system which must determine simultaneously ‘‘who pays’’ and ‘‘who decides.’’

5 Conclusion I will conclude with the closing of Mark’s valuable Handbook chapter on tax incentives: In addition to continuing research on the economic effects of tax-based incentives to refine further our understanding of those effects, there is also a need for comparative research on the forms of incentives and their relationship to various national contexts. Why have particular forms of incentives arisen in certain countries but not in others? What difference does variation in various parameters make in the operation of these tax laws? What are the comparative politics of tax-based incentives? And, finally, while researchers have much to learn from the broader research on tax-based incentives for nonprofit charitable organizations and their various sources of support, sector-based research would also be of interest. Feld et al. (1983) pointed out that changes in tax law will not affect all charitable sectors equally because the demographics of those who choose to fund the arts and culture are different from those who choose to fund other sectors. Is there an appropriate set of taxbased incentives for the arts and culture, one that would be justifiably different from the set available to another sector? Several of the [international]

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examples cited above seem to be based on that premise. But the central analytic question remains: To what extent have they realized their promise? (Schuster 2006, p. 1293) And so even though 25 years have passed since the publication of PDT, there remain many interesting and, it seems to me, feasible avenues of research in the field of tax-based indirect state support of the arts. Mark Schuster provided thoughtful and insightful commentary and research on this topic, the groundwork and the agenda have been set, and we hope a new generation of scholars will accept the task of answering the many important questions that remain.

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