Income or consumption tax: Which one benefits household philanthropy more?

In this paper I try to answer the question of whether an income tax or a consumption tax is better for household philanthropic activity. To answer it I consider both household giving and charitable production. The current personal income tax system in the United States allows itemizing households to deduct money donations, so they give both time and money on a pre-tax basis. It thus discriminates against non-itemizers who give time on a pre-tax basis, but money on an after-tax basis. The consumption tax eliminates this discrimination and has no giving deductions. The income tax system falls on the factors of production the charitable organizations hire, but not on the time donated by volunteers. The consumption tax falls on the charities' purchases of final goods and services but not on the factors of production they hire, thus treating all factors of production, hired and volunteered, equally. By taxing their purchases but not the factors of production, the consumption tax provides an incentive to charities to hire factors of production rather than purchasing finals goods or services.

This discussion shows that it is not clear a-priori which of the two taxation systems is better for household philanthropics, making this is an empirical question. To answer it I setup a general equilibrium model of charitable giving, calibrate it using 2004 data, and then use it to estimate a counterfactual scenario where the personal income tax is replaced by a consumption tax that keeps real government spending constant. Results show that charitable production increases slightly, and that both types of gifts increase. Although the increase in giving is directly related to the taxation burden shift from the households to the charitable organizations, the overall increase in charity production indicates that philanthropic activity increases. Results also confirm that charities would hire more factors of productions and consume less final goods and services. Changes in both types of donations are sensitive to the elasticity of substitution between hired and volunteered labor. When hired and volunteer labor are complements, the increase in time donations is small and the increase in money donations is high. As the elasticity of substitution between hired and volunteered labor increases, households replace money donations for time donations. This change of one type of donation for another is driven by itemizers, whereas non-itemizers’ time and money donations are not clearly affected by the mentioned elasticity of substitution.