Taxing donations

Tweet The furore over the Chancellor’s change to the rules about tax relief on charitable donations has been confusing, as different sides play with statistics to present different pictures of the impact.  There’s been rather more heat than light on the whole. 

The charities stress how much they stand to lose, the large donors threaten to donate less in future, and the government points to the way in which charitable giving reduces the effective tax rate of some of the very rich.  And it seems to me that they’re all correct, despite drawing different policy conclusions from their differing interpretations.

If I correctly understand the tax rules concerning donations, the sums turn out to be surprisingly complex; but let’s take the grossly simplified scenario of two millionaires, M1 and M2, each of whom receive £2 million per annum.  M1 decides to ‘keep’ all his money whilst M2 decides to give half of it away to charity.  And let’s assume, again for simplicity, that the effective marginal tax rate on the whole of their income is 50%.

M1 gets to keep £1 million and the Government gets £1 million in taxes, nice and straightforward.  His tax rate is clearly 50%, and he has a million pounds left over to spend.

M2 pays £1 million to his favourite charity (which then gets a tax credit from HMRC on the basis of an assumption that tax at basic rate has already been paid, meaning it actually receives £1.25 million).  He’s already paid £1 million to the Government in tax, leaving him with nothing, but he can then reclaim tax at the remaining 30% on the grossed-up £1.25 million, so the Government repays him £375,000.  In total, therefore, he’s paid only £625,000 tax on his £2 million – an effective tax rate of only 31.25%, and he has to struggle along on a mere £375,000 for the year.

(And the government has received only £375,000 net – around a third of what it got from M1, which probably highlights their real problem.)

According to the government, M2 is a bad guy, because he’s reduced his effective rate of tax to less than those on smaller salaries will be paying, whilst M1 is a good guy because he’s paid his full whack of tax at 50%.  But which is the better citizen (leaving aside the question of whether either of them deserve to receive £2 million in the first place)?  It’s far from being so clear cut.

Part of the answer might depend on what the chosen charity or charities do, as well as on the perspective of those making that judgement.  From my perspective, a donation of £1 million to Oxfam looks a lot different from a donation of £1 million to another of the UK’s major charities, Eton School.  (And in the second case, my judgement might be further coloured if the donating Millionaire sent his progeny to said school, effectively gaining some personal, or family, benefit from his ‘charitable’ donation.) 

That, though, is really an argument for reviewing the basis on which charitable status is bestowed on organisations, rather than about the tax relief on donations to charities per se.

The more significant question for me is that whole principle of tax relief on charitable donations.  I don’t blame charities for wanting such a system, nor for making the most of it.  And I can understand why governments (of both parties) have used the system to try and encourage more charitable donations – after all, things done by charities mean that they don’t need to be done by government. Voluntary donations are always more popular than involuntary taxes.

But the granting of such generous tax relief means that our friend M2 is actually donating only £625,000 of his own money, and another £625,000 of money which would otherwise go into the government’s coffers.  Is it really his to give?  That’s a much more challenging question than the Chancellor has been prepared to ask.