Legal Commentary

Tax Deductions for American Charitable Donations Abroad--Posner

By Richard Posner

Of some $300 billion in annual American charitable giving, about 5 percent is spent abroad; almost 40 percent of that 5 percent is donated by the Bill & Melinda Gates Foundation, mainly for trying to alleviate Third World health problems (such as malaria and AIDS) and provide assistance to Third World agriculture. Total American charitable giving abroad is more than half as great as total U.S. governmental foreign aid, of which almost a third goes to Israel and Egypt.

Americans do not receive an income tax deduction for giving to foreign charities, but they do for giving to domestic charities that donate abroad (provided they don't just donate to foreign charities). Should they? I am inclined to think they should not.

This is not, however, because I think that government foreign aid is a more efficient method of increasing Third World welfare. Little U.S. foreign aid goes to the Third World, and the efficacy of the aid that does go there is undermined by the requirement that the aid be used to purchase U.S. goods and services.

Nor do I question the economic rationale for providing a tax exemption for charitable donations. The argument is that charitable giving provides an external benefit; that is, if I want to increase the welfare of people in Bangladesh, I will benefit from a charitable donation for that purpose made by someone else and will therefore be inclined to give less. Knowing this, that donor will donate less because the value of his donation is diminished by my free riding on it. There is even an argument that placing any restriction on how a person uses his money reduces incentives to earn, but it is hard to believe that this would be a big effect of eliminating the tax exemption for charitable donations to foreign countries.

Although charitable donations to foreign recipients will thus diminish if the tax deduction is repealed, there is likely to be some substitution in favor of domestic recipients, which will increase welfare in the United States; and that seems to me a good thing, especially in a depression. (Of course, the depression may induce donors to reallocate grants to the United States because the wealth of Americans is less; but perhaps not, because the decline in wealth in the Third World is probably as great or greater.) Also, to the extent that total charitable donations fall, tax revenues will rise, which is also a good thing, given the enormous budget deficits that we face. I suspect, moreover, that charitable donations to Americans create more utility than charitable donations to people in poor countries, because the latter donations reduce pressures for desperately needed political, economic, and social reforms. I doubt that Mugabe would still be ruling Zimbabwe if the West did not provide extensive food to its starving population. I have not seen any attempt at a rigorous analysis of the net benefits of charitable contributions to Third World nations.

There is also some danger that charitable donations to foreign countries undermine U.S. foreign policy. But I do not put much weight on this factor, because the government can forbid donations to countries with which we are at odds, or to other countries where we think aid would undermine our foreign or security objectives. An offset, moreover, is that donations from the United States, even if made by private individuals and foundations rather than by the government, build good will toward Americans.

Full post as published by Becker-Posner Blog on March 15, 2009 (boomark / email).