Capping tax relief? Say what!?
The government is proposing to impose a cap on tax relief for charitable contributions. It says that large donors are using the unlimited relief as a way of avoiding taxes. Opponents of the cap say that it will discourage large donors from making contributions and hurt charity. The debate on the proposal has really taken center stage in the media in the last few weeks and shows no sign of abating – there will even be a special Radio 4 broadcast devoted to a discussion of tax relief and charities. And now the government says it won’t do anything about imposing a cap until consultation has taken place.
I don’t know who the government is planning to consult, but the proposed cap falls flat on economic grounds: it is a plan that targets all donors, not just those that may be avoiders; it is not based on clear evidence about the effects of the policy or about avoidance in the first place; and the administrative plan for implementing the policy seems non-existent.
Where is the evidence that some large donors are using charitable contributions as a way of avoiding tax? How big is the problem? Who are these people? If there is avoidance, which part of Gift Aid is relevant – tax relief for capital gains on gifts of property to charity, what? Government is pretty silent on this, but the answers are important. How can any policy be evaluated if we don’t know about the costs and benefits of the problem and its fix?
Well, let’s forget about that – the duck is in the air and we shouldn’t concern ourselves with its takeoff. Suppose avoidance is taking place and it really is a big problem. Then tell us which element of the tax relief system is more vulnerable to being used as a channel to avoid taxes: is it the deduction from tax for cash contributions made by higher rate self assessed taxpayers? or is the avoidance more likely to happen on the relief given for capital gains (very generous)? As all first year economics students know, sound economic policy requires that tax instruments are targeted directly to the problem at hand. Using a generic cap on tax relief to charitable contributions in order to fix tax avoidance is, metaphorically speaking, rather like spraying a room full of people with machine gun fire in hopes of killing a fly on the wall, hardly a rational and efficient way of killing the fly especially when a fly swatter would do the job quite nicely and it wouldn’t kill all the people in the room. It is a bit astonishing that the people formulating public policy in this country seem to have missed that very important point.
Let’s even forget about the lack of targeting. Tell me about the evidence about the effects of the proposed policy. Why should we care about the evidence? Because the policy is designed to improve government finances: increasing revenue and reducing spend on public services. But will it? It all depends on how donors react. Maybe they will react by cutting donations and/or by reducing the amount of taxable income that they earn. Possible? Likely? We will have no idea without some evidence. However, if that happens, donations would fall (which would mean more government spending on public services might be needed) and so might government revenue. I think everyone would agree that implementing a policy that generates such self-inflicted wounds is a bit bonkers.
But we don’t know if there will be self-inflicted wounds such as these. Is there any evidence at all? Hmm … well, maybe there is but nobody in government has told us what it is. Absent some statement to the contrary, it seems that the proposal has been formulated without any evidence – theoretical or empirical – about its possible effects on avoidance and/or donations. In fact, the best available evidence can found in this report, written by myself and my coauthor. There, a very small number of large donors were asked hypothetical questions about how changes in tax relief on donations might change their giving behaviour (some said it would change their behaviour, some said it wouldn’t) and about whether tax relief mattered in their decisions (some said it did and some said it didn’t). This kind of evidence is useful as a starting point, but it is only indicative and not predictive and so should not be used to underpin an ad hoc policy affecting a sector of the economy that receives about £6 billion pounds per year from more than 50% of the population.
Let’s forget the lack of evidence about tax avoidance, the fact that the proposed cap would not only target avoiders but rather all donors, and the fact that there is no evidence base underpinning the possible effects of the policy. Suppose the proposed cap is actually implemented. What then? How would it be administered? I have no idea, and it appears the government doesn’t either since I have not heard a comprehensive statement about it.
So what to make of all of the fuss? I’m afraid that from where I sit the proposed cap on tax relief for charitable contributions does not make a lot of economic sense: it is not a remedy targeted to the problem of tax avoidance; it is not underpinned by theoretical or empirical evidence that would allow us to make a prediction about its effects; and, if it gets that far, I suspect it will be an administrative nightmare to implement. I would really like to have been the proverbial fly-on-the-wall when the good folks at HMRC or the Treasury came up with the plan, although I might have died, either from laughing at the lack of logic or from the spray of bullets.