DOES TAX POLICY AFFECT EFFICIENCY? - EXAMINING THE EFFECT OF DONOR CHARITABLE TAX INCENTIVES ON NONPROFIT PROGRAM RATIOS

Abstract

Using state charitable tax subsidy rates to proxy for tax incentives, I examine the effect of donors’ charitable tax incentives on the relation between donor contributions and nonprofit organizations’ (NPOs) program efficiency, following Weisbrod and Dominguez (1986) who model a negative relation between charitable tax incentives and NPO program efficiency. I focus my study on NPOs with large donors (i.e., donors that make a single contribution of $5,000 or more) because large donors are more likely to be the beneficiaries of these tax incentives given that the incentives lower their after-tax cost of giving. In addition, NPOs typically appoint large donors to the board, which places these donors in a position to influence NPO efficiency. I use Form 990 Schedule B data to identify NPOs that have one or more large donors, and I find that as state tax rates increase, an increase in donor contributions is associated with higher NPO program efficiency. The results suggest that contrary to the expectations of Weisbrod and Dominguez (1986), tax incentives do not have a negative effect on NPO program efficiency in NPOs with large donors. Rather, my results are consistent with large donors having higher efficiency expectations and being more likely to ensure that the NPO operates efficiently. Given that large donors on the NPO’s board can influence NPO program efficiency and based on the expected negative effect of taxes on the relation between donor contributions and NPO program efficiency predicted by Weisbrod and Dominguez (1986), I further examine whether the effect of donor tax incentives on the relation between donor contributions and NPO program efficiency in NPOs with large donors differ by board size, board independence, and state regulations. While the coefficients indicate that tax incentives have a more positive effect on the relation between donor contributions and NPO program efficiency for NPOs with large board sizes compared to NPOs with small board sizes, Wald statistics indicate that the results do not differ statistically between NPOs split by board sizes. However, the results examining the effect of board independence indicate that NPO program efficiency is higher in NPOs with independent boards compared to those with non-independent boards, suggesting that an independent board has a positive differential impact on how tax incentives affect the relation between donor contributions and NPO program efficiency. Conversely, the results indicate that there is no statistical difference in the effect of tax incentives on the relation between donor contributions and NPO program efficiency between samples split by state regulations. Taken together, the results suggest that while NPO board size and state governance do not impact how tax incentives affect the relation between donor contributions and NPO program efficiency, an independent board has a positive impact on how tax incentives affect the relation between donor contributions and NPO program efficiency. In additional tests, I use changes in state tax rates to examine the effect of tax incentives on the relation between donor contributions and NPO program efficiency. The results show that state tax rate changes (decreases and increases) do not affect the relation between donor contributions and NPO program efficiency. I also conduct tests using federal tax changes to proxy for tax incentives. I first exploit the exogenous shock from the 2017 Tax Cuts and Jobs Act (TCJA) to examine changes in program efficiency, and the results are statistically insignificant, indicating that the TCJA had no effect on the relation between donor contributions and NPO program efficiency. Thereafter, I use the percentage of itemizers in each state as a proxy for tax incentives, and the results also suggest that the percentage of itemizers does not affect the relation between donor contributions and NPO program efficiency.