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The Economics of Charity

Burton A. Abrams Mark D. Schitz

• University of Delaware

“The ‘crowding out’ Effect of Governmental Transfers on Private Charitable Contributions.” Public Choice 33 (1978): 29–40.

Does governmental welfare discourage private charity?

Many studies trace how government spending affects interest rates and price levels, but few studies have investigated the effects of government spending on private spending habits. How, in particular, do social welfare transfers affect private charitable contributions?

Since World War II, government spending on welfare has increased more rapidly than private charitable contributions. Private charity per tax return has remained the same despite the tax advantages of charitable donations. What explains this paradox is the growth of government welfare spending.

Private charity has frequently been characterized as a public good subject to a free rider problem. Yet charity allows sufficient noneconomic motivation to overcome the reluctance for individuals to donate charity (specifically, the motivation to “do good”). However, the number of charitable contributions depends upon personal tastes, income, and the relative cost of making such contributions.

Within this framework, increasing government transfers will have two effects on private transfers: (1) a substitution effect (government transfers will be taken as substitutes for private charity), and (2) an income effect (increased taxes used to finance transfers will reduce private incomes and hence private charity). The income and substitution effects can be analyzed by three models of private charity. The first, the ultra-rational, hypothesizes that a private individual regards government spending as his own so that he considers one dollar of government transfer is equivalent to one dollar of private donations. This model would predict complete crowding out of private charity. The second model includes interdependent utility functions between donor and recipient so that increases in government transfers lower the marginal utility of an additional dollar to the recipient, and hence donors contribute less. This would predict partial crowding out. The third model, the “better to give than to receive” hypothesis, assumes satisfaction is obtained from the act of giving, and hence there would be no substitution effect but some income effect.

The authors tested an empirical model in which contributions depended upon the cost of giving (marginal tax rate), income, and the number of government transfers. The findings were that government transfers do crowd out private donations. The substitution effect alone shows a .2 percent decrease in private donations for every one percent increase in government transfers. With the income effect added in, the total effect of crowding out is about 28 percent.