The Rich Versus The Rest?

‘Toward a New Social Contract’ is the theme of this year’s Global Philanthropy Forum, currently taking place in Washington, DC. But the real hand-to-hand fighting on the role that philanthropy plays in the rich’s responsibilities to society is being played out in Britain, where a government initiative to cut the tax subsidy to giving has sparked a national conversation that has led to some unlikely alliances and some fascinating debate. The world should pay attention because the issues under discussion are relevant to every society, and the conversation is long overdue. When our book on Philanthrocapitalism first appeared nearly four years ago, we called for a new social contract between the rich and the rest, and, in the final chapter, laid out a crucial part of such a contract in the form of a ‘Good Billionaire Guide’ by which society might judge the behaviour of the wealthy.

For those wondering what the fuss in Britain is about, a quick recap. Prime Minister David Cameron thinks that government is too big and that the nation would be a happier place if more people gave time and money to sort out social problems through voluntary organisations rather than leaving it all up to the state. As part of this effort, his government has talked a lot about promoting more philanthropy. Yet his finance minister, George Osborne, recently announced a new measure to restrict the tax relief that any single charitable donor can claim to £50,000 ($75,000) or 25% of their income. Cue shrieks of horror from charities and philanthropists, since this would hit the richest donors (who currently pay a top whack tax rate of 50%) who want to give away more than a quarter of their income. According to the #giveitbackgeorge campaign organised by British charities, it is a decision that could cost the voluntary sector up to £1 billion a year. We note, in passing, that British charities have never been so vocal about their love for the rich. The voluntary sector is giving the 1% the best PR they have had in ages!

(Incidentally, the debate may be loudest there, but Britain is not alone in raising the tax subsidy question. Barack Obama’s administration has made several attempts to reduce the tax relief on charitable donations by the rich, though none has yet made it through a deeply divided Congress.)

Much of the debate in Britain is horribly confused, but it has touched on three main issues, each of which deserves to be taken seriously:

1) Does philanthropy deserve a subsidy? Obviously, says the philanthropy lobby. But is it that obvious? Taxes forsaken by the government mean less money to spend on politically agreed priorities, and charitable donations may go to causes that aren’t a big priority for society.  “[I]t might be preferable for the rich to pay their taxes to contribute to the NHS [National Health Service], schools or tax credits [welfare] rather than to make tax free donations to opera, theatre or, even, other charitable causes”, mused the BBC’s political editor, Nick Robinson.

This makes a good debating point, conjuring up images of wealthy (presumably fur-coated and top-hatted) plutocrats stuffing the mouths of the arts establishment with gold to win prestige points, plush seats and general sucking up. But, on substance, this misrepresents what is really being subsidised by the taxman: most giving goes to health and social causes, not the elite arts. Moreover, back in 2006 Britain went through a whole review of charity law which resulted in it describing a ‘public benefit’ that any organisation must meet to qualify for charitable status. True, such public benefit does not necessarily align with current public spending priorities .But actually that may be a strength of philanthropy, to pick up on causes that are outside political priorities (and most critiques of the current rules defining public benefit boil down to the different personal preferences of the particular critiquer). Nor would it be practical to keep redrawing the definition of how charity delivers public benefit every time political priorities change.

But there is an important lesson for other countries: the effort that Britain has invested in agreeing a public benefit test and funding the Charity Commission to (up to a point) police this test ought to provide some reassurance that the taxpayers’ subsidy is being well used. In other countries, including the United States, that have looser rules on qualification for tax-deductible status, it is harder to justify the status quo. Nor should philanthropists in Britain or elsewhere be complacent. The fact that philanthropy is associated in the public mind more with opera than saving lives says something about the failure of philanthropists to communicate how they are spending their money. This is why one of the pillars of our Good Billionaire Guide is that philanthropists should be effective in their giving as well as generous, including being transparent about what they are doing and why.

2) What’s the tradeoff between paying tax and giving to charity? The whole brouhaha in Britain revolves around a deal struck by the governing coalition whereby the minority Lib Dems agreed to a cut in the top rate of tax from 50% to 45% in return for a crackdown on tax loopholes. The restriction on the tax deductibility of charity is one way that the reduction in the top rate of income tax for the richest can be clawed back.

To understand what this all means, let’s look at a (highly) simplified example. A rich person earning £4 million a year would currently owe £2 million in tax (less, in fact, but let’s assume the 50% rate applies to the entire income). If she gives away £2 million she can reduce her taxable income to £2 million and therefore cut her tax bill to £1 million. Under the new rules (and let’s assume that there’s still a 50% tax rate, for ease of illustration), the first £1 million given away (one quarter of her income) is still taken off her taxable income but the second is not, so she pays 50% of £3m, hence she pays £1.5 million tax. The government’s argument is that under the current rules, by giving away half her income our high earner can cut her effective tax rate to 25%, lower than many people poorer than her (people start paying 40% income tax at around £45k a year in Britain). Under the new rules, she’d be paying 37% tax (£1.5m tax on £4 million income), which is more like her fair share, says the government. In making this argument, David Cameron’s government is echoing what has become known as the “Buffett Rule”, based on financier and philanthropist Warren Buffett’s argument that there is something wrong with a tax system where a billionaire such as he pays a lower rate of tax than his secretary.

The principle expressed in the Buffett Rule is surely right and should shape policy around tax loopholes, as we argue in our Good Billionaire Guide. Philanthropy, however, is different from other loopholes because, at least in theory, the donor gets no personal financial reward for her generosity and, subject to the caveats above about public benefit and effectiveness, society gains. Our donor, for example, gives away £2 million in order to cut her tax bill by £1 million. That, to us, looks like a pretty good deal for society and not something that should be discouraged.

[Two technical caveats: a) The public benefit of tax-subsidised philanthropy is diminished if that £2 million goes into a charitable foundation and just sits there, or is dribbled out very slowly. To  mitigate this risk, Britain should adopt a minimum payout rule for foundations, similar to the one that currently exists in the United States; b) There is a suggestion that the government may offer ‘lifetime legacies’ (by which a donor can gift, say, a painting and claim the tax relief up front but continue to use that asset for the rest of her life) as a sop to the philanthropy sector. This would defer the social benefit while front-loading the tax subsidy, which strikes us as bonkers.]

3) Do the rich deserve their wealth? It is notable that support for the government has come from a surprising direction. Polly Toynbee, a veteran big government liberal Guardian columnist, has waded in to the debate to defend George Osborne’s move, arguing that philanthropy is no substitute for the rich paying their taxes. So too, curiouser and curiouser, has Financial Times columnist Philip Stephens. The interesting commonality in their arguments is their framing of the rich as undeserving. Stephens’ hypothetical philanthropist spent “a lifetime fleecing the clients of a US investment bank” (boo, hiss); Toynbee goes for a real-life ‘villain’ in Stanley Fink, who she snottily points out is a “godfather of the British hedge fund industry” and, to heap coals on his head as far as Guardian readers are concerned, is also the Conservative Party treasurer (double boo, hiss).

These are cheap shots but the argument does speak to the final pillar of our Good Billionaire Guide: that philanthropists should earn their money honestly. We argue in the book that this is a crucial question for the super-rich of emerging markets, particularly those earning spectacular wealth from extractive industries or government granted monopolies (especially those acquired through dodgy privatisations) – arguments that have been reinforced by the latest global economics blockbuster, “Why Nations Fail“. In markets with proper competition laws and property rights we are less concerned. Nor do we take Toynbee’s jaundiced view of hedge funds. Yet, even if you disagree with us, if there is a problem of ill-gotten gains then tackling it through curtailing tax exemptions on giving is like using a nutcracker to break a boulder. It is a distraction from the issue under debate.

The #giveitbackgeorge campaign has merit because the British policy is poorly thought out, unlikely to raise much money for the Treasury, and likely to damage charities at a time when they are particularly vulnerable. Yet, as we have argued from the outset, that does not mean that all is well with the status quo on the tax treatment of giving, which is ripe for wider reform. This scare for Britain’s charity sector should prompt it to do a better job of explaining why it needs its tax privileges, and ideally how the tax treatment of its activities could be improved (even in the absence of any increase in the tax subsidy).

Donors in other countries, not least America, should take heed. In these difficult economic times, the 1% are going to be under growing pressure to show that they really are making a positive contribution to society through their giving. The debate about what, if anything, makes a good billionaire is coming their way soon. Better get ready.