Private provision of public goods: incentives for donations

The purpose of this paper is to examine the commonly used policy approach to subsidize the private provision of public goods by granting agents deductions with respect to their income or corporate tax burden.

In the framework of a microeconomic representative agent model the commonly used policy approach to subsidize donations by granting agents deductions with respect to their income tax burden is examined. The paper especially considers that most income tax schemes are progressive and deductibility is limited. After pointing to the problems arising from these specific properties of tax‐refund schemes the paper turns towards the effects that such a tax‐refund scheme has with respect to donations on the one hand and welfare on the other hand.

Findings shows that the effects of the commonly practiced methods of supporting donations depend crucially on the specific properties of the tax scheme and preferences of agents. While Pareto‐improvements and even Pareto‐efficiency can result from the implementation of such a scheme, it is also conceivable that some agents perceive a utility reduction.

The analysis builds on a static approach although taxation also exerts important dynamic effects. These effects have been neglected in the current paper as the interaction of taxation and preferences is already quite complex. However, they should be considered in future research.

Owing to the dependency of welfare effects on the tariff structure, income tax reforms as they are planned in many countries might not only induce a reduction in donations, but might as a result also alter the induced welfare effects.

The paper shows that the generally applied tax‐refund schemes constitute no effective means to induce optimal donation levels. Implications depend crucially on, e.g. deductibility ceilings and progressiveness of tax rates.