Tax Effect of Charitable Contributions At Corporate and Individual Levels
- I. The Cost of Contributions.
- A. $1000 contribution made by firm, directly.
- 1. Firm earns $1000 and contributes it to Princeton.
- 2. Firm takes deduction of $1000 in calculating its corporate profit.
- 3. Firm therefore has $1000 less profit, for tax purposes.
- 4. Tax is 30% of firm's marginal profit, so $1000 reduction in profit means that taxes are reduced by $300.
- 5. Net cost to firm is $700: that is, the $1000 contribution, less $300 in saved taxes.
- 6. Net cost to shareholders is $350: Without the contribution, the firm would have paid $300 in taxes, leaving $700 to distribute as dividend, and shareholders would then have paid $350 in taxes, leaving $350.
- B. $1000 contribution made by individual shareholders out of dividends.
- 1. Firm earns same $1000.
- 2. Firm pays $300 taxes.
- 3. Firm distributes remaining $700 to shareholders as dividend.
- 4. Shareholder contributes $700 and owes no taxes.
- 5. To contribute remaining $300, shareholder must cause the firm to pay an additional $300 dividend.
- 6. To pay a $300 dividend, firm must earn an additional $428 (it will pay 30%, or $128, of that in taxes, leaving $300 to pay as a dividend).
- 7. Therefore, to make a $1000 contribution, firm must earn $1428 instead of $1000.
- 8. Net cost to shareholders is $500 instead of $350 -- without the contribution, $1428 in corporate earnings could fund $1000 in dividends, and shareholders would have retained $500 after personal taxes.
- C. Comparison and Conclusion.
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For the same earnings, the corporation can make a contribution that is almost half again as large (or, looked at the other way, the same contribution requires almost 1/3 less earnings) by making the contribution directly rather than paying a dividend to shareholders who will then make it. The difference is picked up by the taxpayers.
- Thus, rational taxpaying shareholders (who are not concerned about issues of national policy, the national debt or democratic process), will, if they can agree on a process for determining to whom to make contributions, prefer to have the corporation make the contribution rather than making it individually. Rational taxpaying citizens may or may not wish the law were different.
- II. Other Values.
- A. Individual autonomy issues: Should shareholders be deemed to have appointed corporate management to determine for them the content of their charitable contributions?
- B. Captive voice/free speech issues: What options are available to a shareholder who disagrees with corporate management?
- C. Private taxation issues: Should private groups not elected by one- person, one-vote or universal suffrage be entitled to tax for public purposes? Is it a valuable check on centralized government, or merely an anti-democratic aristocratic remnant, to have non-governmental power structures (i.e., corporations) making significant decisions about the allocation of tax revenues (or, more precisely, non-revenues)?
- D. Ownership issues: The above analysis assumes that the corporate money being donated belongs to the shareholders and that the only problem is determining how shareholders want it distributed. But is that correct?
- E. Noblesse Oblige Issues: Corporations are significant wealthholders in our system. Shouldn't they be encouraged to redistribute some of that wealth to worthy causes and/or the needy? Should this encouragement be at the expense of the democratically elected government's ability to determine how to allocate social resources? And see 3. above.
- F. Citizenship issues: Corporations are significant political entities in our polity. Should(n't) they be allowed, encouraged, or required, to participate fully?
- G. Collective action/free rider issues: Corporations may be able to overcome some free rider problems that might afflict individual shareholders -- using collective resources more effectively to promote the interests of shareholders (as perceived by management). Is this good or bad?
Assume:
- a 50% personal income tax rate and an 30% percent corporate tax rate;
- shareholders wish to make a $1000 contribution to Princeton;
- shareholders control corporation and can treat its assets as their own.
How much will the contribution cost them?
In your view, should the law presume that shareholders wish to take advantage of this tax break?
Consider the following:
Standard microeconomic theory states that at competitive equilibrium, the firm cannot earn an extraordinary profit: the price of its product must equal the marginal cost of production (including a normal return to shareholders). So a firm making charitable donations must be earning an extraordinary return from some disequilibrium -- most likely, some type of monopoly power. Presumably that monopoly power is not with respect to shareholders: the stock market is generally considered to be among the most competitive markets in our economy, and shareholders could easily refuse to invest if they were receiving less than a market return on their money. (This conclusion assumes that the corporation doesn't suddenly change a settled practice by unpredictably or secretly making newly large donations). It would seem to follow that the donated funds belong to the victims of that monopoly power, i.e., the underpaid workers or overcharged customers, not to shareholders.
If you accept this analysis and conclude that the funds "belong" to customers or employees of the firm, not its shareholders, which way does that cut? Why should the elected representatives of the stock determine to whom to contribute funds "belonging" to employees or customers? Would customers or employees have any legal right to receive the funds if they were not donated? Would shareholders? Who would decide? Should that decision be made by the courts?
Corporations may be more or less susceptible to other free rider problems than, for example, the federal or state governments. How does this affect a decision regarding whether they should be granted tax subsidies for charitable contributions?