THE OPTIMAL FISCAL TREATMENT OF CHARITAaLE ACTIVITY

This paper presents the results of research carried out within a broader study of the economics of charitable activity in conjunction with Mr. A. ABSTRACT Discussion of the optimal fiscal treatment of charity has hitherto been restricted largely to consideration of an efficiertcy (or externality) justification for subsidies to charity, and in particular. to the optimal tax treatment of charitable contributions. This paper takes a broader perspective: It examines the fiscal treatment of charities as a whole-that is, both the ta~ treatment of contributions and the tax exemption of the income of charitable organizations-and identifies the possible forms of fiscal treatment suggested by both equity and externality rationales. The first main conclusion is that an explanation of the fiscal treatment of charity on equity grounds offers little rationale for the tax deductions of contributions, but may, in certain limited circumstances, provide a convincing case for limited tax exemption. The second conclusion is that a comprehensive treatment of the efficiency or externality argument-that is, including the case of several charities serving ·different objectives-suggests that the.most appropriate subsidy system is one which varies subsidies between charities on the basis of their output rather than on the basis of total income, as is the case at present. It follows that in certain circumstances a variable direct grant (awarded to some but not necessarily all recognized charities) may be more appropriate than the current combination of tax exemption and tax deduction.