The Optimal Tax Treatment of Charitable Contributions

Utilizing the criteria of efficient resource allocation and distributional neutrality, this paper examines the optimal method of subsidizing charity. It focuses, in particular, on the use of a tax credit as an alternative to the current method of deducting eligible contributions from adjusted gross income. Unlike many other analyses of this question, it does not employ traditional equity arguments; it proposes, rather, that subsidies, justified by the public good or externality charactenstics of chanty, should be structured to effect a Lindahl solution. The principal conclusion is that a tax-credit system may well conform more closely with such a solution and the criteria it satisfies than the current system.