Subsidizing the Wealthy As They Make Charitable Contributions to Themselves

It is well-known that free-market capitalism was a failure leading to intolerable economic volatility.  It was the capitalists themselves who recognized the need to control markets when they set up monopolies called “trusts” intended to dominate particular industries in such a way that prices could be controlled and competition inhibited.  This state of affairs was not particularly satisfactory to consumers and generated government regulation to inhibit the formation of monopolies.  What evolved from this contention between capitalists and government regulation was the realization that each side needed the other and an accommodation was required if the system was to work efficiently.

Robert B. Reich has assessed this balance between markets and regulation in his new book Saving Capitalism: For the Many, Not the Few.  He concludes that the required balance between capitalists and regulation has been lost.  Those who have acquired great wealth have used the power that wealth can buy to control government regulation and use it to increase the ability of the wealthy to grow wealthier at the expense of the rest of the population.  In Reich’s view we are living under an oligarchy, and we must begin to organize in order to regain a “countervailing” political power.

Reich provides numerous examples to support his contention.  The intent here is a discussion of ways the tax code has been used to protect the wealth of the wealthy, making sure that little of it gets redistributed.  Reich organized his thoughts in two dueling chapters; the first was titled The Rise of the Working Poor followed by The Rise of the Non-working Rich.  It is the latter we will focus on here.

Reich claims that those who have acquired great riches can pass enough of their assets on to their children that our nation is beginning to look like one of those nineteenth-to-early-twentieth century European aristocracies.

“Consider that in 1978, the richest 1 percent of households accounted for 20 percent of business income.  By 2007 they accounted for 49 percent.  They were also taking in 75 percent of all capital gains.  By 2014, the value of the stock market was significantly higher than it was before the crash of 2008.  Accordingly, the top was earning substantially more from their investments and acquiring even more of all capital gains.”

“America is on the cusp of the largest intergenerational transfer of wealth in history.  A study from the Boston College Center on Wealth and Philanthropy projects that $36 trillion could be passed down to heirs in the half century leading up to 2061….It is about to become the source for a new American aristocracy.”

There are many ways to avoid paying taxes on assets.  Perhaps the most troubling are those that use the “charity” tax deduction to obtain what is essentially a subsidy provided by tax payers to support whatever actions are being taken.  It is an example of what is known as a tax expenditure.  Tax expenditures add up to about $1 trillion each year.  They are equivalent to taxes being gathered and redistributed to those eligible for a transfer.  The wealthy are the greatest beneficiaries of these transfers.  While our income tax rates are progressive, these giveaways are regressive in the sense that funds are preferentially transferred from lower income taxpayers to higher income taxpayers.

Let us refer to two articles written by Lewis B. Cullman.  Cullman is a wealthy old man who has given many millions to charitable causes.  He was in a bad mood when he wrote an article for The New York Review of Books in 2003.  It was titled Private Foundations: The Trick.  Scam would have been a more appropriate term, but Mr. Cullman is apparently also a gentleman.  He was still angry more recently when he returned to the same publication with a new article: Stop the Misuse of Philanthropy!

Cullman explains how “charity” is used to create and pass on dynastic wealth to succeeding generations.

“The next time you read about a rich person donating $100 million to charity, you should be aware that this seemingly generous gift may never actually reach the institutions that need it. The chances are that the donation is being used to set up a private foundation. The gift will earn the donor a full deduction against income or estate taxes. But the little-understood trick of this form of philanthropy is that the $100 million that launched the foundation need never go to charity.”

The “trick” involves hiding behind the IRS requirement that private foundations must spend at least 5% of their assets each year.  However, the IRS does not require those funds be issued as a grant of some sort.  It is perfectly legal to charge 5% against the assets for administration costs.  Consider also that it is relatively easy for smart money managers to earn (tax free) at least 5% on multimillion dollar nest eggs.  Given that private foundations have no termination date, a charitable foundation could go on forever without donating a significant amount to charity.

Now consider the wealthy person who wanted to avoid estate taxes and still provide for his children.  The $100 million could be administered by a son or daughter or multiple offspring.  This task would provide a salary and expense account worth millions every year that could be passed on to subsequent generations.

Cullman claims to have given about $500 million for actually charitable purposes and is outraged at the misuse of supposedly charitable contributions allowed by our tax system.

“Recent estimates indicate that at least $700 billion is tucked away in private foundations, money that could be doing good for charities and for the economy—and you and I as taxpayers have underwritten the tax benefits awarded those foundations.”

Reich provides an estimate of how much is lost each year in allowing tax deductions and sheltering earnings from charitable entities.

“In economic terms, these deductions and tax-free earnings are the equivalent of government subsidies.  In 2011, the last year for which good data are available, they totaled an estimated $54 billion….To put this into some perspective, $50 billion is more than the federal government spent in 2011 on the Temporary Assistance for Needy Families program (what’s left of welfare), school lunches for poor kids, and Head Start put together.”

Although the details of how it is done might be unfamiliar, it has always been known that the wealthy have ways to protect their assets and pass them on.  Reich also provides a glimpse at the less familiar mechanisms by which the tax system allows us to subsidize the rich as they funnel money to their favorite educational institutions.

“Another portion goes to the elite prep schools and universities that benefactors once attended or want their children to attend.  (Such institutions typically give preference in admissions to applicants and legacies whose parents have been notably generous, a kind of affirmative action for the wealthy.)  Harvard, Yale, Princeton, and the rest of the Ivy League are important institutions, but they do not educate large numbers of poor young people.”

“Private university endowments in 2014 totaled about $550 billion, centered in a handful of prestigious institutions.  Harvard’s endowment is more than $32 billion, followed by Yale at $20.8 billion, Stanford at $18.7 billion, and Princeton at $18.2 billion.”

Because of the charitable deduction any contribution to these extremely wealthy institutions is actually coming out of our tax payments at the rate of about 30 percent.  In addition, the income and capital gains earned by these endowments goes untaxed—in other words we taxpayers provide a subsidy to cover the taxes that should have been paid.  The sum of these subsidies is enormous.

“Add in these endowments’ exemptions from taxes on capital gains and on income they earn, and the total government expenditure is even larger.  Divide by the relatively small number of students attending these institutions, and the amount of subsidy per student is huge.  The annual government subsidy to Princeton University, for example, is about $54,000 per student, according to an estimate by economist Richard Vedder.  Other elite private universities aren’t far behind.”

Now compare this with the level of public support received by students at public universities which are not generally in possession of large endowments.  These institutions receive most of their funding from state and local governments, and that level of support has been rapidly falling.

“….the average annual government subsidy per student at a public university comes to less than $6,000, about one-tenth the per-student government subsidy at Princeton.”

Reich also makes sure we are aware that government subsidies are being used to increase the inequality in funding of public schools in the K-12 range.  These schools are mostly funded by property taxes.  Consequently the higher the property values the higher the level of funding for the local schools.  Some states and localities have attempted to correct this inequality by allocating funds at comparable rates per student.  What is new about this situation is that things called “parents’ foundations” are becoming common as a mechanism to feed extra money into particular schools.  These foundations have the same tax privileges as university endowments, providing a government-subsidized mechanism that allows them to provide better education for their own children—and avoid contributing funds via taxes for a better education for all children.

Laura McKenna provides a discussion of these foundations and their impact in an article in The Atlantic: How Rich Parents Can Exacerbate School Inequality.

“Clearly, affluent communities have greater financial resources to support their schools. Parents there also have the time and social capital needed to organize elaborate fundraisers and fill out the lengthy legal paperwork required to establish these foundations. With these enormous resources, parents in affluent communities can raise far more money for their schools than parents in other locations.”

“This extreme fundraising prowess is seen in wealthy communities across the country. Some parents groups at elite public schools in New York City, for example, raise so much money that their schools have earned the nickname “public privates.” School foundations at places like Brooklyn Tech, raise millions to fund science equipment, guest lecturers, and scholarships for summer programs. An elementary school in a wealthy area of Chicago raised $400,000 in one night with an auction that included airfare to vacation homes (while another school in a less-affluent neighborhood raised only $8,000 for the entire year with bake sales and book fairs). The school foundation for Woodside, California, will hold an auction in May that includes six tickets, a makeover, and a limo to a Taylor Swift concert (valued at $3,700), a shopping spree at a jewelry store (valued at $15,000), and a week at a vacation home in the Hamptons (valued at $15,000).”

McKenna quotes Rob Reich (not Robert Reich) a Stanford professor and co-director of its Center on Philanthropy and Civil Society.

“Reich….pointed out that when wealthy people give money to their town foundations, their tax-deductable donations stay in their own communities. The contributions enhance the schools’ success, which in turn increases the donors’ property value. In other words, the rich receive tax credits for giving money to themselves. ‘All of us are subsidizing the magnification of inequality in public schools,’ he told me. ‘It’s preposterous’.”

“These highly educated, affluent parents, he said, use their finite energy and wallets to do some something that exclusively benefits their children. As a result, the parents may be less likely to advocate for policy changes that would benefits kids in other school districts, taking away some of their ‘political voice,’ Reich theorized. Instead of going to Trenton or Albany to fight for public schools, they are running the town’s science fair.”

Robert Reich provides this reckoning of how much “charitable” giving actually reaches poor people.

“A 2005 analysis by Indiana University’s Center on Philanthropy showed that even under the most generous of assumptions only about a third of ‘charitable’ giving is targeted to helping poor people.”

We would become a better society if we eliminated the charity tax deduction and used the funds gained to augment our pathetic social support system.  The main problems with our education system are poverty and the increased isolation of the rich from the poor.