Does understanding tax laws reduce charitable giving? A study of tax literacy and unintended consequences

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Charitable organizations often try to encourage giving to their organization by highlighting the tax benefits one may receive, but in reality, most taxpayers do not actually qualify for a tax benefit for charitable gifts.  

What many people may not know is that charitable contributions can only be deducted as an itemized deduction, and it will only benefit taxpayers to itemize their deductions if the sum of their allowable expenses exceeds the standard deduction.  

Prior to the TCJA (Tax Cuts and Jobs Act) tax law overhaul in 2017, approximately one-third of taxpayers itemized their deductions, but that percentage is now closer to 10-15% of taxpayers due to limitations imposed on itemized deductions as well as a significantly higher standard deduction.

A new study from The School of Business at Portland State University examines how much the average taxpayer understands when it comes to possible tax benefits of charitable giving, and what might happen if they knew more. 

Accounting Assistant Professor Cass Hausserman and colleagues published the study, “Does Understanding Tax Laws Reduce Charitable Giving? A Study of Tax Literacy and Unintended Consequences,” in the Journal of Advances in Taxation

The researchers discovered that fewer than half of taxpayers understand the basic principles of how charitable donations affect tax liability, but that a short educational video was extremely effective at improving taxpayers’ understanding and helping them accurately estimate the tax benefit associated with charitable giving. 

However, the researchers also found that participants who received this educational intervention and accurately estimated the tax benefits, in turn, decreased their charitable giving. This likely happens because most taxpayers do not understand whether and how they benefit from certain deductions, and may be overestimating the tax benefit they receive from charitable giving, resulting in giving more than they intend.

 “While we weren’t hoping for people to give less to charities, we were extremely excited to see that a two-minute educational video improved basic tax knowledge so significantly,” said Hausserman.

Two videos were created in this study for participants to watch. One was an educational video focused on how charitable donations affect tax liability and the other was a video for their control condition, which talked about different types of charities and how they use their funds. Half of the participants saw the tax education video while the other half viewed the control video. 

After watching their respective videos, participants were asked to read a hypothetical scenario in which they had to make a charitable giving decision, as well as estimate the tax savings related to their donation. They were also asked some basic questions to approximate their understanding of the tax benefits of charitable giving.  Less than 40% of participants who viewed the control video got each of these basic questions correct, while more than 95% who viewed the tax education video got the same questions correct. 

“It turns out that many people either overestimate the tax benefit they will receive or think they will receive a tax benefit when they will not,” said Hausserman.

The researchers also analyzed the links between the educational intervention, understanding of the tax laws and charitable giving decisions. The research revealed a strong link between these three variables, such that the educational video affected understanding, which in turn affected giving decisions.  

Specifically, the more taxpayers understood the less they gave to charity, which is likely due to the fact that they were previously overestimating tax benefits from giving. The most pronounced effects of the educational video were for participants who were told their donation would be tax deductible as opposed to those who were told it would not be deductible.

 “ We told participants whether or not any possible donations they made would be deductible,” said Hausserman.“But I think in the real world, the educational video would be even more impactful because many people don’t even know whether or not they itemize their deductions and therefore whether their donation would be deductible at all.”

The study has implications for charitable organizations and policy-makers alike.  The researchers suggest that there is likely a similar effect happening with other tax deductions and credits that are even more complex than the deduction for charitable giving.

 “While it may not seem like good news for charities, many participants still chose to donate to charity even when they fully understood the tax consequences,” said Hausserman. “We think it is important for people to understand the impact their donation will have on their taxes and are encouraged that such a simple intervention provided average taxpayers with the knowledge to make more informed decisions.” 

This study was conducted by Hausserman and co-author Amy Hageman from Kansas State University.