The Tax Bill’s Poison Pill

By now pretty much everyone is aware of the massive tax bill that is expected to be voted into law this week by Congress. If you are a hedge fund manager, you are pretty happy right now. If you are a nonprofit CEO or CDO, well… not so much.

The proposed House bill, pitched as the “Cut Cut Cut Act” by President Trump but officially named the Tax Cuts and Jobs Act, includes a provision that would nearly double the standard deduction to $12,200 for an individual and $24,400 for a married couple.

Raising the standard deduction would reduce the number of taxpayers who itemize deductions — including charitable donations — from the current 30 percent to 5 percent, experts say.

An excellent analysis of the impact of virtually eliminating the deduction for charitable giving was published recently by Dr. Patrick Rooney, a professor of economics and philanthropic studies at Indiana University’s Lilly Family School of Philanthropy. Rooney estimates that the new tax bill will result in a 4.6 percent decline in household donations to nonprofits, more than $13 billion when compared to what American households gave in 2016. We are concerned that it may be even worse. Here’s why.

Like most things explained by behavioral economics, people are not rational actors with regards to charitable giving. Although people engage in many altruistic behaviors, the language they use in explaining their actions most often emphasizes their own self-interest. When talking about why they volunteer, they tend to say things like, “It gave me something to do,” “I liked the other volunteers,” or “It got me out of the house.”

In his book, Acts of Compassion, Princeton sociologist Robert Wuthnow describes the difficulty people have acknowledging that they are motivated by genuine compassion or the desire to help others. People Wuthow interviewed went out of their way to stress that they were not “bleeding hearts, goody two-shoes, or do-gooders.”

Research has consistently shown that the expectation of receiving a tax benefit is a significant factor in motivating people to make charitable donations. On the face of it, that seems irrational. If someone is donating $1,000 expecting to get a $300 tax savings, why wouldn’t they just give $700? Clearly, something else is at play.

Receiving a tax deduction for charitable donations provides people with what psychologists call an exchange fiction. The deduction allows them to attribute their altruistic acts to a more self-interested reason for acting compassionately. When people get a tax deduction in exchange for a donation, they don’t have to feel like a do-gooder. They can explain their behavior as something they can feel good about, but not as something that implies that they have a responsibility to support other causes, or even the same cause they just donated to in the future.

The offer of an exchange creates a fiction that allows people to act on their altruistic impulses without a psychological commitment to do more. It gives them an excuse for donating. It allows people to feel good about “doing their part” without committing themselves to an open-ended relationship with the organization that they might not want to continue in the future.

That is why nonprofit CEOs and CDOs should be very, very concerned about the reduction in the number of people who take advantage of the charitable tax deduction. The deduction isn’t really about bottom line savings. It is the psychological value of the deduction, not the actual dollars saved, that makes tax-deductible donations so attractive to people.

So, nonprofits should expect to take a significant hit in revenue next year because of the tax bill. One way to stem the bleeding may be to increase their investment in peer-to-peer fundraising. According to DonorDrive, P2P is now the fastest-growing space in both giving and fundraising.  In addition to the reliable walks and runs, DIY fundraising is rapidly expanding; the number of organizations adding DIY campaigns to their fundraising in DonorDrive grew by 125% over the past two years.

Here’s why emphasizing P2P is smart. Dutch scholars recently conducted a meta-analysis of 500 studies to identify the key factors that drive donating. They concluded that for more than 85% of charitable donations, people gave because someone asked them to. P2P leverages social relationships. When you are solicited for a donation by a peer – a friend or family member – pretty much nobody asks for a receipt so they can write it off on next year’s tax return.

Will upping your P2P game offset the consequences of the Republican tax plan? No. But doing so will position you to better weather the storm. The good news? The next election is less than a year away.