The Problem with the Estate Tax Charitable Deduction

By Harry S. Margolis

Many years ago, my law school friend and current Boston College Law School professor, Ray Madoff, wrote an op-ed article in The New York Times on the topic of Leona Helmsely’s $8 billion bequest to a foundation for dogs. Professor Madoff’s thesis was that $3.6 billion of this bequest come out of our pockets as taxes, since the charitable deduction avoided the then 45% federal estate tax. (The federal rate is now 40%, but only on the excess over $11.7 million.)
Madoff further explains that since the foundation is only required to spend 5% of its assets a year, including the administration costs, the foundation may last forever to the greater benefit of the foundation officers than the dogs it is supposed to assist. Madoff called for a limit on the federal charitable deduction so that the taxpayer no longer subsidizes the whims of rich benefactors.
A lot of very rich people have left a lot of money to private foundations that do a lot of good in the world. Think of the Ford Foundation or the Bill & Melinda Gates Foundation. But some create foundations that do little good. Think of the Trump Foundation. In either case, whether the foundations are funded during life or at death they benefit from substantial tax avoidance.

Does the Trade Off Make Sense?

The purpose of the tax deduction is to encourage charitable giving. Would the Ford or Gates families have funded their foundations if it were not for the tax deduction? (I think we know the answer with respect to former president Trump.) And, either way, is the trade off worth it? Is it worth the federal government giving up $400 million of tax revenue in order to incentivize the creation of a $1 billion foundation?
If you think the donor would make the gift with our without the tax benefit, then are we as a people better off with $1 billion in the foundation or with $600,000 million in the foundation and $400 million received in taxes? In other words, does the foundation contribute more to the public good than our tax dollars do? Do you think the private directors of the foundation do a better job deciding how the funds are spent than our duly-elected representatives? And is it okay that for the most part the funds are invested rather than being spent on charitable causes? Does the fact that perhaps only $50 million a year will be distributed change the calculation?
Whatever your answers to all of those questions may be, do the answers change if you conclude that the choice isn’t between $1 billion to charity and $600 million to charity and $400 to taxes, but between $1 billion to charity and $0 to charity and $400 million to taxes? While you might prefer the tax revenue if the balance would still go to charity, you might be willing to forego the tax revenue as leverage to incentivize the huge charitable contribution.

Two Possible Reforms

There are a couple of possible ways to split the difference. One is to limit the amount an estate may deduct as a charitable contribution. On the income tax side, except for certain qualified charities, taxpayers may deduct no more 60% of their adjusted gross income each year. Perhaps the same limit should apply to the estate tax charitable deduction.
Another approach would be to make sure the funds set aside are distributed more quickly rather than remaining as a monument to the donor in perpetuity. Perhaps all private foundations should be limited to a 20-year lifespan or required to distribute 10% of their assets each year, rather than just 5%. Either approach would make them distribute more to those in need more rapidly.
What do you think?

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