On the Desirability of Taxing Charitable Contributions

According to an annual survey, Giving USA, total charitable giving in America in
2004 amounted to $ 249 billion, over 2 percent of GDP. This outstanding figure
reflects, in part, a response to what has been a consistent policy of US government
since 1917 to grant favorable tax treatment to charitable contributions in order to
promote philanthropy. Charitable contributions are accorded favorable tax treatment
elsewhere too. This favorable treatment takes a variety of forms, including tax
deductions or tax credits.

From a public economics point of view, a key reason for subsidizing
charitable contributions derives from a Pigouvian motive. Looking at private charity
as a voluntary mechanism for the provision of public goods implies that in the
absence of intervention, individuals tend to overlook the positive externality their
contributions exert on the rest of the community (the classical free-rider problem).
This will be the case even when individuals derive utility from the act of giving itself,
which provides them with an extra incentive to donate ['warm glow' approach as in
Andreoni (1989, 1990)]. Recently, Diamond (2006) provides a novel argument in
favor of the conventional wisdom about subsidizing charitable contributions. He
points out that subsidizing private donations may mitigate the incentive constraints
associated with income taxation, thereby allowing the government to attain further
redistribution.

De-Botton (2005) points out that in a modern society, individuals' concerns
about how they are being perceived by others have evolved to a level of anxiety.
Following the work of Frank (1984a, 1984b, 1985a and 1985b) on the demand for
status, there seems to be another motive for contributing; namely, the desire to
demonstrate wealth. While there are other means to signal status, notably through

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