The Impact of Taxes and Wasteful Government Spending on Giving

Abstract

We examine how taxes impact giving to charity and how this relationship is affected by the degree of wasteful government spending. In our model, government collects a flat-rate tax on income net of charitable donations and redistributes part of the tax revenue. The rest of the tax revenue is wasted. The model predicts that (i) a higher tax rate increases charitable donations, (ii) a higher rate of waste increases (decreases) donations when the elasticity of marginal utility is low (high), and (iii) the marginal effect of the tax rate on donations is always larger than the marginal effect of the rate of waste on donations. We test these predictions using a laboratory experiment with actual donations to charities. We find that the tax rate on average has a weak and insignificant effect on giving. The degree of waste, however, has a large, negative and highly significant effect on giving, with the relationship being moderated by the elasticity of marginal utility. We discuss potential policy implications of our findings.