Andrew Pyle
December 15, 2023
The taxman stars in the next Grinch sequel
We covered a lot of financial markets ground in our conference call on Tuesday night and again after the FOMC meeting, so I thought we would switch things up today and look at something that doesn’t get enough airplay in Canada – the state of charitable giving. We indeed live in a wonderful community, filled with big-hearted people. Throughout the year, we try to help as many groups as possible, through volunteering our time and/or providing financial support, and this time of year is always special as we pay our regular visits to these groups. This week, it was our pleasure to visit with some of them.
There are so many causes and agencies in this good country that derive all of their funding from the generosity of individuals and businesses, such that their livelihood becomes inextricably linked to the state of the economy and the performance of financial markets. In recent years, there has been enough challenges to both, to put pressure on the capacity and willingness to donate. People are more willing to give when they themselves feel they are in a stable position to do so. Well, a pandemic brought health and financial consequences. Overly aggressive monetary policy easing fueled the highest inflation in decades and put significant pressure on household and business budgets. Yes, there were temporary cash injections that helped through these storms, but today we are faced with higher debt levels alongside higher prices.
This time last year, the Fraser Institute published a bulletin entitled “Generosity in Canada: The 2022 Generosity Index” (Copyright ©2022 by the Fraser Institute) – an annual report on the level of private monetary generosity nationally and across provinces. The study looks at two variables – “the percentage of tax filers donating” and “percentage of aggregate personal income donated”. The main feature of the bulletin was that every province and territory in Canada saw a decline in the percentage of filers donating between 2010 and 2020, but all jurisdictions also experienced a drop in the percentage of personal incomes going to donations. Yes, this doesn’t take into account 2021, 2022 and this past year, but I believe that the pattern probably hasn’t shifted. That would be especially true coming out of 2022, when portfolios suffered a major setback from both bonds and equities.
This is a disturbing trend to be sure and one, especially given that the level of personal disposable income in Canada grew by close to 50% from 2010 to 2020 according to Statistics Canada. By the end of 2022, it had grown 62%. One of the reasons is that incomes have not kept up with household debt. Even though the ratio of household and non-profit institution debt to disposable income fell through 2020 (thanks to government stimulus), the ratio was still more than 10 percentage points higher than back in 2010. Since 2020, the ratio has risen again and was above 180% at the end of the third quarter. This doesn’t tell the whole story, as the nominal dollars spent to service debt has increased substantially since 2021 due to higher interest rates.
Given the trend decline in giving metrics, you would think this would prompt fiscal authorities to look for remedies. The debt issue in Canada is a serious one to be sure, however, the main segment of the population where this is going to be felt the hardest is in the lower to medium income brackets. In fact, a report from Statistics Canada last year (The Daily, April 12, 2022) found that while the dollar amounts of donations in 2020 rose, the total number of donors fell 0.6%. The percentage of smaller donors also fell, though made up for by larger donors (with elder Canadians still the largest single group).
So, you might say, why worry? If all that is happening is that less donations are coming from lower income groups, but higher-income households are compensating, charitable organizations should be fine, right? And the total dollar value of donations still rose from 2010 to 2020, even if concentrated in a smaller number of donors. Well, for one, reliance on a smaller segment of the population isn’t necessarily a sustainable model. Second, we are about to see a less advantageous environment for higher-income donors in 2024, thanks to the introduction of new Alternative Minimum Tax (AMT) rules starting January 1st.
I covered this briefly in our year-end tax commentary a couple of weeks ago, but this week’s visits with various charities hit home how little these changes by the federal government have been discussed and how some Canadians may want to re-think their timing for charitable donations on the basis of the new rules. The government laid out these changes to address fairness in the tax system, targeting high-income individuals who may use certain provisions in the tax code to reduce their overall rate of taxation. The two main areas these rules went after was the treatment of capital gains and charitable donations in the calculation of AMT.
Specifically, the new AMT rules target charitable giving by (A) disallowing half of the charitable donation tax credit, and (B) taxing 30% of the capital gains on donations of publicly listed securities. Again, a relatively small percentage of the population is going to be impacted by the new AMT rules (or the current ones for that matter), yet it has already been shown that it is this segment that has provided much of the growth in donations, if any.
An E-Brief by the C.D. Howe Institute last month (“Capital Gains and Charitable Donations: The Silent Targets of Federal AMT Reforms”) examined the impact that the new AMT rules would have on fiscal variables, but also on behaviour. In the case of charitable giving, there is clearly an incentive for high-income individuals to donate, but if the effective tax advantage is reduced, then the study finds that this can act to reduce the incentive to give.
One of the principles behind a lower taxation on capital gains is that it incentivized the movement of capital from stagnant holdings to ones with more growth potential, thus reinforcing flows into potentially more innovative and promising ones. It also helps individuals rebalance their investment portfolios as they age and enter periods of life with their risk profile declines. Donation of securities was an effective way of allowing these people to do so with less of a tax impact, especially those that may not be viewed as ultra-high net worth individuals, but just had long legacy holdings with large unrealized capital gains.
Hence, the new AMT rules could have two (hardly unpredictable) negative effects. One is that it continues the downward trend in terms of the value of donations relative to income, thus hitting charities further in a still high inflationary environment. Two, it causes older Canadians to hold on to legacy securities longer than they should, inviting inappropriate allocations of medium to high-risk securities in their portfolios. It is true, that tax should not be an impediment to correct investment decisions, but we all know that investor behaviour doesn’t follow a textbook all the time. The message to charities is to remind their donors that there could be advantages to gifting securities now and the message to investors is to speak with their tax professionals and advisors like us to determine if there are advantages to doing something before 2024 when the new AMT rules hit.
On behalf of the Pyle Wealth Advisory team, have a wonderful weekend.
Andrew Pyle
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