Pete Rose and Dikembe Mutombo, the retired sports stars, are famous for very different reasons -- Rose for his gambling, Mutombo for his philanthropy. The Baseball Hall of Fame permanently barred Rose from induction for betting on the Cincinnati Reds, his own team. The National Basketball Association twice awarded Mr. Mutombo the J. Walter Kennedy Citizenship Award for his humanitarian work combating infectious diseases like polio.
The two strike a fitting contrast to illustrate a point about the new tax law enacted as part of the "fiscal cliff" deal and the coming battle over the presidential budget.
One might think that U.S. tax policy would favor philanthropic behavior over gambling, but the exact opposite is true. As a result of the fiscal cliff deal, the deduction for charitable contributions is limited, but the deduction for gambling losses -- up to the amount of gambling winnings -- is not. In 2013, it is better to gamble than to give.
This is all a result of the "Pease" limitation, which reduces certain itemized deductions. It lowers the charitable deduction by 3 percent of adjusted gross income above $250,000 for singles and $300,000 for married couples, for a maximum reduction of 80 percent of itemized deductions. But some deductions are excluded from the Pease limitation, and the deduction for gambling losses is one.
Charitable contributions should be treated more favorably than gambling losses because they are not a form of personal consumption -- after all, the charity consumes the gift, not the donor. Gambling losses, on the other hand, are an entertainment expense. At the very least, gifts to charity should be treated no worse than gambling losses. If the deduction for gambling losses is exempt from Pease, the same should go for charitable gifts.
Pease is a clever trick to raise revenue, but it is a headache to calculate, and it creates perverse tax policy. For some generous taxpayers, it creates a significant disincentive to give. At the moment you make a gift, it is difficult to know if or by how much Pease will limit its deductability, because that is determined by yearly income and other deductions. The more your income exceeds $250,000, the more Pease will limit your charitable deduction, which complicates matters. And again, Pease bites the hardest on those who are wealthy and generous. Those who prefer gambling to charity get off scot-free.
There are good reasons to carve out charitable deductions from the Pease limitation that transcend the debate about federal revenue. The purpose of the charitable deduction is to maintain the independence of civil society from the government. As Justice John Marshall once put it, "The power to tax involves the power to destroy." By carving charitable gifts out of the tax base, the charitable deduction helps to maintain the separation of church and state. It also preserves Americans' freedom to form, fund and operate charitable organizations, giving substance to our constitutionally protected freedom of association. The deduction enables American civic engagement with minimum government interference.
Moreover, charitable gifts should not be taxed because many charities rely on them for funding. According to the National Center for Charitable Statistics, the United States has approximately 900,000 public charities, 100,000 private foundations and 320,000 religious congregations. Charitable giving is essential to preserve this part of our society. If the government were to tax charitable gifts, it would blur the lines between the government and an independent charitable sector. Yet Pease, in its awkward way, does just that. By limiting the charitable deduction, Pease pulls a portion of charitable gifts back into the tax base.
Both Right and Left should agree on the importance of maintaining an independent civil society. Exempting the charitable deduction from Pease therefore should be a political win for both sides.
Charities should support efforts to exempt the charitable deduction from Pease, and they should work hard to persuade the president to exempt the charitable deduction from the 28 percent cap on itemized deductions that he has proposed in the past four presidential budgets. But at the very least, our tax law should not treat philanthropists worse than it does gamblers.
Alexander Reid is of counsel in Morgan Lewis's Tax Practice and former legislative counsel for the congressional Joint Committee on Taxation. He is chairman of the Tax-Exempt Organizations Committee of the District of Columbia Bar and is vice chairman of the D.C. Bar Tax Section Steering Committee.