On the Desirability of Taxing Charitable Contributions

The existence of a strong status-signaling motive for contributions alongside
the altruistic one has two implications for the design of the tax treatment of charitable
giving. First, on efficiency grounds, there is a case for taxing contributions as a means
to internalize the negative externality associated with status acquisition Second, on
equity grounds, a signaling motive renders charitable contributions an extremely
efficient 'tagging device' [as in Akerlof (1978)] of the high-ability individuals who
seek to signal their social status.³ This may call for taxing contributions as a
supplement to the labor income tax system in order to attain enhanced re-distribution.

Status effects have been examined by the labor income tax literature. Boskin
and Sheshinski (1978) is an early study that incorporates status in the design of the
optimal income tax. They employ a model in which individuals care not only about
their absolute income level but rather also about their relative income level. However,
they analyze only the externality effect of status, as individuals do not engage in
signaling in their model. More recently, Ireland (1998 and 2001) employs a model in
which individuals signal their social status through consumption choices. He focuses
on the design of the income tax schedule and rules out the possibility of direct taxing
of the consumption signals.⁴ In the present study we develop a model that allows for
public goods and status signaling through charitable contributions. This model
provides a unified framework in which contributions are driven both by altruism and
status signaling. We use this setup to re-examine the conventional practice of
rendering a favorable tax treatment to charitable contributions.

³ A recent survey of Philanthropy by The Economist (February, 2006) cites a study by Schervish of
Boston College, showing that American Families with a net worth of 1 million dollars or more,
accounted for 4.9 percent of the total number of donations to charitable organizations in 1997, but as
much as 42 percent of the value.

⁴ See Ireland (2001) for discussion of the difficulty of directly taxing consumption signals.

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