Charitable Giving and Tax Policy in the Presence of Cheating

We develop a model of charitable contributions in the presence of “cheating” contributions and present formulas for the optimality of tax subsidies for contributions. In addition to the standard price elasticity of reported charitable contributions, two new parameters appear in the formulas: the share of “cheating” contributions in total reported contributions and the price elasticity of “cheating” contributions. Then, we provide substantial evidence that ignoring cheating parameters is likely to lead to large deviations from the optimal subsidy. We use two tax enforcement reforms: the 1969 tightening of rules for contributions to private foundations in the United States and a 1983 French reform requiring taxpayers to document their contributions. In both cases, we find sizeable responses to the tax enforcement regime, implying that the share of “cheating” contributions that we estimate is significant. We also find that the price elasticity of reported contributions falls significantly after the 1983 French reform, allowing us to back out the price elasticity of “cheating” contributions. A simple calibration based on our estimates shows that the issue of tax evasion through charitable contributions is a first-order consideration for the design of optimal subsidies in the U.S. system.