America’s tax breaks for charitable giving could be better spent

It is looking like the US Treasury will have given up more than $50bn in deductions to compensate the wealthy for their charitable donations last year.

So, as President Joe Biden draws up tax reforms to pay for an infrastructure bill, it is a good time to ask: is that $50bn a decent use of public money? Especially when much of it subsidises gifts transferred into the burgeoning numbers of opaque and under-regulated donor-advised funds (DAFs)?

Last year’s charity-linked tax relief is a fifth higher than the equivalent estimate for 2019. But there almost certainly wasn’t a one-fifth increase in giving to charities. The money has instead got stuck in the financial plumbing, to the benefit of almost no one except those running the system.

A survey of US non-profits suggests they squeezed out a 2 per cent rise in funding in 2020 — a year when food banks were overwhelmed and the problems of racial injustice were laid bare. A year after the pandemic hit, employment at charities and other non-profits in the US was down 7 per cent, according to Johns Hopkins University data.

Yet the money bottled up by financial intermediaries surged in 2020. Assets held by private foundations passed the $1tn mark, up 7 per cent, while DAFs — philanthropic investment accounts from the likes of Fidelity and Vanguard — probably grew even faster, given that they had been rising so rapidly in previous years. Between 2014 and 2019, they had doubled their assets to $140bn, across close to 1m individual accounts. Like foundations, DAFs hold money that has been earmarked for giving but not yet donated to operating charities. In both cases, the donor banks the tax break immediately. In effect, they have written an IOU to US society.

At least foundations have to distribute a modest 5 per cent of their assets each year; DAFs have no payout requirement at all, despite the even more generous tax benefits that underpin their explosive growth. Contributions to these vehicles appear to be growing at twice the rate of donations to operating charities.

DAF users tend to distribute a larger percentage of their funds each year than foundations, but some estimates suggest as many as one in four DAFs may be making no donations at all. Meanwhile, foundations have started using DAFs to skirt their own payout requirements, since — extraordinarily — moving money into a DAF counts towards their own 5 per cent quota. And, once the tax break has been banked, no one has a financial incentive to speed up the giving. DAF providers can charge for managing the money. There is also the natural human tendency to delay, and donors worry about committing to the wrong causes or groups. Little wonder the money is proving easier to put in than give out. The coming Biden tax reform is an ideal moment to insert a few new incentives into the system.

“My message is, the charitable act is actually distributing the money from the DAF into the community and that’s what the tax code should reward,” says John Arnold, a billionaire former hedge fund manager campaigning for reform. With a group of academics and foundation leaders, he has set up the Initiative to Accelerate Charitable Giving and has drawn up a list of potential tax tweaks. The biggest change would be to offer DAF donors a choice between delaying the application of their tax write-off until money has left the fund for a real charity, and taking it now but committing to distribute the money within 15 years.

Others might argue for a tighter timeframe, but the initiative is pitched as bipartisan, art-of-the-possible stuff. There is some hope it will find a receptive ear. The Cares Act passed last year to stimulate the US economy included a modest expansion of tax breaks for philanthropic giving that excluded DAFs. Arnold’s initiative would certainly improve the return on the Treasury’s $50bn. Call it an investment in America’s charitable infrastructure.

For those who ask what the hurry is, since the funds in DAFs are generating investment returns and society will eventually be paid its IOU with interest, the former hedge fund manager reaches for a mathematical answer. Society’s problems “are compounding as well”, he says. “Look at investing in low-socioeconomic [status] neighbourhoods that are trapped in poverty. If you invest today, you might have very beneficial long-term effects. If you don’t, the problems compound on themselves. It’s cheaper to do it today than to wait till tomorrow.”

This article is part of FT Wealth, a section providing in-depth coverage of philanthropy, entrepreneurs, family offices, as well as alternative and impact investment.