On the Desirability of Taxing Charitable Contributions

directly affect contributions by either taxing or subsidizing them (through deduction
or credits).

The rationale for these results is straightforward. When constraint (11) is
binding (μ₂ > 0), there is an excess provision of public good. In this case, the
government employs the tax on contributions in order to shift resources from public
good provision towards redistribution. In contrast, when constraint (11) is not binding
( μ₂ = 0), then the government is indifferent, at the margin, between allocating its
revenues to the transfer (T) or the public good (g). Because a tax on contributions
shifts resources from the public good to the transfer, there is no social gain or cost
generated by such a tax. These results suggest that the reason for taxing status-driven
contributions derives from the fact that the contributions themselves cannot be readily
translated into redistribution, whereas the tax revenues can be.¹²

5. Conclusions

The conventional practice is to render a favorable tax treatment for charitable
contributions, either through deductions or credits. The economic rationale for this
practice is essentially Pigouvian: contributions for the financing of public goods
generate a positive externality. In this paper, we point out that contributions may be
also driven by a status-signaling motive. Therefore, as a pure signal, contributions
generate also a negative externality. Moreover, contributions may be employed by the
government in order to sort out the wealthy, and enhance redistribution.

Both considerations challenge the conventional practice. Naturally, whether
and to what extent favorable tax treatment should be rendered to charitable
contributions crucially depends on the relative strength of the altruistic motive vis-à-

¹² We thank an anonymous referee for this observation.

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