Compelling recent events have thrust the need for charitable giving into the spotlight on the world stage. Kimberley Scharf and Sarah Smith investigate how potential changes in UK tax policies could affect donations.
The recent tragedy unfolding in Haiti exposed human need in heart-rending detail. The global recession has led to a surge in demand for charities that help the growing ranks of the unemployed and the needy both at home and abroad.
At the same time, with many governments considering ways to cut spending, institutions that have long relied on public monies increasingly find themselves turning to private sources of fundraising. State-supported universities seeking charitable donations from alumni and other donors are but one example.
Against this backdrop, our research explores how possible tax changes in the UK’s Gift Aid programme might affect donors’ decisions about how much money they give to charitable causes.
Surprisingly, our analysis suggests that donors who are eligible to receive rebates on charitable giving are unlikely to reduce their donations if the rebate component were to end. For charities, this suggests that the total funding available to them would be likely to increase if the government were to redirect the rebates for which higher-rate taxpayer donors are eligible, and instead offer the money to charities through a matching programme.
Donors eligible for tax rebates on charitable giving are unlikely to reduce their donations if the rebates should end
The Gift Aid programme provides tax relief on money donated to charities by treating donations as if the donor had already deducted the basic tax rate of 20%. The programme has two key provisions:
- The first provision involves a “match” for charities, allowing them to reclaim the tax portion of a donation. That is, for every pound donated out of net-of-tax income, a charity can reclaim 25 pence, equal to the 20% rate of relief on the gross equivalent donation.
- The second provision involves a “rebate” for donors who are in a higher tax rate category, of at least 40%. These donors may receive a rebate of the tax payable on the portion of their income they devote to charity. For every pound donated out of net-of-tax income, higher-rate taxpayers can thus reclaim an additional 25 pence, corresponding to the difference between the higher rate and the basic rate of income taxation.
Our study is based on online surveys of nearly 4,000 donors who had recently given to Gift Aid through JustGiving or the Charities Aid Foundation’s Charity Account – two popular, UK-based “giving portals” through which private donors channel their donations to the charities of their choice.
Donors were asked to consider how their donations might change under two alternative scenarios. In each hypothetical scenario, the rebate eligible for higher-rate donors would be eliminated and replaced with an increased match that the charities could claim directly, at different hypothetical levels. The two options were:
- Redirection: under this scenario, charities could reclaim 50 pence for every £1 donated out of net-of-tax income by higher-rate taxpayers (identified by a tick box on donation forms). Charities would continue to reclaim the 25 pence for every £1 donated by basic-rate taxpaying donors.
- Composite rate: under this scenario, charities could receive a higher level of match for donations, regardless of whether they came from higher-rate or basic-rate taxpayers. For the survey, two composite rates were proposed: 30 pence and 37 pence per £1 pound donated out of net-of-tax.
Separately, researchers conducted extensive interviews with major donors who had given more than £100,000 a year to charitable causes.
The survey results suggest that a switch from a tax rebate to a donation match as a method of delivering government support to private giving may result in an increase in total gross donations. This is the case even when the rebate and the match offer equivalent levels of support – and might therefore be considered as being fully equivalent from a narrow economic perspective.
Switching from a tax rebate to a donation match would probably lead to an increase in charities’ revenues
The majority of people eligible for rebates do not claim them. When asked why they would not adjust their donations, the majority said it was because they had decided how much to give before thinking about the tax incentives.
The survey’s results are surprising in that we might expect donors to prefer a system that essentially reduces the price of giving. Separate research by one of us (Kimberley Scharf) on the motivations behind these preferences suggests that the behaviour can be explained with a model of “rational inattention,” with donors deciding whether the details of the rebate merit are worth the investment of time they require.
The basic insight is that you are more likely to pay attention if you think it is going to be costly not to pay attention. If the cost of making a mistake by not paying attention to the rebate is low, donors decide to ignore it. As the mistakes donors can make by neglecting to process changes in the rebate are potentially larger than those that could result from ignoring changes in the match, donors will respond differently to the two types of changes.
Our analysis will help researchers develop a better understanding of the myriad motives behind charitable giving, and help refocus debate about how donations are affected by tax incentives that lower the price of giving to charity. More broadly, it shows that the economic choices that individuals make can be significantly affected by the degree of complexity of the calculations involved.
This article is based on Gift Aid donor research: Exploring options for reforming higher-rate relief by Kimberley Scharf and Sarah Smith, a research report commissioned by HM Revenue and Customs on behalf of HM Treasury.
Kimberley Scharf is a professor in the Department of Economics at the University of Warwick. Sarah Smith is a senior research fellow at the Centre for Market and Public Organisation at Bristol University.