Simulating Nonlinear Tax Rules and Nonstandard Behavior: An Application to the Tax Treatment of Charitable Contributions

This paper examines how the tax simulation method can be extended to incorporate nonlinear budget constraints and nonstandard economic behavior. We simulate the effect of extending the charitable deduction to nonitemizers and study the effect of alternative "floors". The specific simulations indicate that the econometric evidence on charitable giving implies that extending the charitable deduction to nonitemizers would raise individual giving by about 12 percent of the existing total amount or $4.5 billion at 1977 levels. The extension would reduce tax revenue by slightly less, about $4.1 billion. A floor of $300 or 3 percent of AGI would reduce the revenue loss by 30 to 40 percent, even if there is significant bunching. The effect of the floor on increased giving depends critically on whether taxpayers' behavior is guided by conventional demand principles or by the net altruism rule. A reasonable conclusion is that a floor would reduce giving by less than the increased revenue but that the difference between them would not be very large.