Taxing Charitable Donations? Then Tax Volunteers
Senior Editor, CNBC.com
My argument that if we are going to fully tax income donated to charity then we should logically tax volunteering also has, so far as I can tell, persuaded absolutely no one. That's not at all surprising to me and doesn't in the slightest bit deter me from trying, at least once more, to state my case.
To really understand this idea, its helpful to imagine two accountants—I'll call them Donald and Victor—who work at a $90 hourly rate. Let us suppose that neither of them donated or volunteered, and billed around 5 hours per weekday, or 25 hours per week. This would give each of them an income of $117,000. To make the math easier, lets just estimate an effective tax rate of 30 percent. This means that each accountant would pay $35,100 in taxes and have an after- tax income of $81,900.
How does the situation look if we introduce charity into the picture? Let's say Donald donates 2 percent of his gross income to charity, or $2,340. Donald's pre-tax but post-charity income is reduced, therefore, to $114,600.
Victor, on the other hand, volunteers for about 2 percent of his time. This reduces his pre-tax, post-charity income by the exact same amount, $2,340, and leaves him with exactly as much income as Donald: $114,600.
Under the principle that equal incomes should be taxed equally, Victor and Donald should receive the exact same income tax treatment. Each has reduced his income through charity, although Donald has done it through donations and Victor has done it through diverting his labor to volunteering.
This is actually what our income tax code does. It does not tax Donald on the income he earned and donated, and it does not attempt to assign an implicit income value to Victor's donation. The income deduction Donald uses and the non-recognition of Victor's volunteering value result in the equal treatment of their equal incomes.
(Read more: Charity Is Charity, Tax-Wise)
If we were to eliminate the deduction for charitable donations—as many tax reformers propose—the results would be a preference for Victor's volunteering. His volunteering would reduce his income but Donald's would not. Even though both would have the same pre-tax income, Victor would have more income after taxes.
There may be good policy reasons to support volunteering over donating. Perhaps we think that actually getting involved is better for the soul than just cutting a check. But there would be counter-weights to this argument, including the idea that it is more efficient to have people working in their profession, respecting the concept of division of labor, and donating income.
In any case, we should at least be aware of that we're setting up the tax code to tax these two equal incomes unevenly, incentivizing volunteering over donating. This isn't a policy choice we want to make by accident, blind to the consequences.
One way to cure this imbalance in tax treatment, and restore the principle of equal incomes taxed equally, would be to tax the time spent volunteering. Just as Donald is denied the ability to reduce his taxable income by donating, Victor is denied the ability to reduce his taxable income by volunteering.
The stumbling block most people have in this argument is the idea of implicit income and donation that is entailed in taxing volunteering. Because there is no actual receipt of funds by the volunteer that are then transferred back to the charity, people imagine that taxing implicit income is impossible.
But it is no more impossible than it taxing income donated to charity. When a person surrenders funds to a charity, those funds are no more personal income to the donor than to the person who never receives the income. The only difference is that we have an accounting record of the money.
We could easily create an accounting record of volunteer-time implicit income. All that would be needed is a rate sheet that calculated an average hourly implicit wage by income brackets. Basically, just take the total income and divide by some measure of what we think is the median total hours worked per year. Each hour volunteering would then create an hour's implicit wage that would add to the amount of taxable income.
The point here is that "taxable income" is always and everywhere an artificial construct. It's really not much stranger to create an implicit income scale for Victor than it is to claim that Donald has income he actually does not, because he handed it over to a charity.
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