National Tax Journal
Vol 49 no. 2 (June 1996) pp. 193-213
TAXES AND CORPORATE CHARITY
TAXES AND CORPORATE
CHARITY: EMPIRICAL
EVIDENCE FROM MICROLEVEL PANEL DATA
JAMES R. BOATSMAN
SANJAY GUPTA *
*
&
Abstract - This paper explores the
relation between corporate contributions and tax rates to examine whether
corporate philanthropy is motivated by
profit maximization or managers’ utility
maximization, the two basic models of
corporate giving that exist in the
literature. No relation between contributions and tax rate is consistent with
profit maximization, whereas either a
positive or negative relation is consistent
with investment in contributions beyond
the profit-maximizing level. The
empirical analysis is based on firmspecific longitudinal data on contributions and estimated marginal tax rates
for a five-year period spanning the Tax
Reform Act of 1986 (TRA86). The results
are consistent with managers’ utility
maximization being an important
motive for corporate contributions, but
contributions beyond the profitmaximizing level are limited by a
binding minimum profit constraint. In
addition, the results indicate that the
income elasticity of corporate contributions is low, ranging from 0.04 to 0.17
depending on how income is defined.
These estimates are much lower than
reported previously with aggregated
data and firm-specific cross-sectional
data.
INTRODUCTION
Contributions to charity by U.S. corporations grew significantly during the
1980s, both in absolute and relative
terms. The level of giving increased from
$2.4 billion in 1980 to $4.5 billion in
1985 to over $6 billion by the end of
the decade.1 Although much smaller in
magnitude than contributions by
individuals, corporate charity represents
about 14 percent of all nonreligious
giving (Clotfelter, 1985). More importantly, when expressed as a percentage
of net income, corporations currently
give approximately two percent of their
pretax income, which is double the
roughly constant rate at which they
gave from the 1950s through the 1970s
and twice the rate of individuals’
nonreligious giving (Clotfelter, 1985;
IRS, 1988).
*
School of Accountancy, Arizona State University, Tempe, AZ
85387-3606.
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NATIONAL TAX JOURNAL VOL. XLIX NO. 2
The income tax deduction for corporate
charitable contributions is controversial.2 The controversy stems in large part
from the long-standing debate over the
propriety of corporate charity (Clotfelter,
1985; Navarro, 1988a). Conservatives
have argued that the deduction
subsidizes a flagrant abuse of shareholder property. Corporate contributions
are said to be undertaken more to
stroke the egos of managers than to
generate profit for shareholders. In
short, contributions are merely another
form of perquisite in which utilitymaximizing managers have an incentive
to overinvest. Liberals, on the other
hand, were not only responsible for
making the deduction legal but have
staunchly supported maintaining and
liberalizing this deduction on the
grounds that corporations have a social
responsibility to give to charity. Interestingly, both camps implicitly assume that
corporate philanthropy is motivated by
reasons other than profit maximization.
The purpose of this study is to provide
new evidence on the role of taxes in
influencing corporate charitable
behavior by (1) using firm-specific
longitudinal data for a sample of 212
firms over five years spanning the Tax
Reform Act of 1986 (TRA86) and (2)
using an estimate of each firm’s
marginal tax rate based on a technology
described by Shevlin (1990). A secondary purpose of this study is to provide
new estimates of the income elasticity
of corporate contributions from firmspecific longitudinal data.
The approach in this study differs from
and has some advantages over the
previous research. First, we use firmlevel data. Most prior studies used IRStabulated data, which are based on
federal corporate income tax returns
and are aggregated by size of corporate
assets and by major industrial groups.
As Navarro (1988a) points out, aggregated data are not amenable to
controlling firm-specific determinants of
giving. Moreover, aggregation obscures
within-group variation in marginal tax
rates.3 Second, we use panel data for a
five-year period beginning in 1984—a
period spanning the rate changes
introduced by TRA86. All prior research
used pre-1986 data—when corporate
tax rate schedules were essentially flat
within years and fixed over time.
Accordingly, little of the cross-sectional
variation in average tax rate observed in
prior studies is attributable to variation
in marginal rate. Rather, the observed
cross-sectional variation in average rate
is due largely to variation in base. As
Slemrod and Shobe (1990) note, panel
data are particularly suited to analyzing
behavioral responses to taxation if the
data span statutory rate changes, since
such data exhibit rate changes that are
independent of income changes. In
addition, panel data estimation techniques can control for unobserved
Previous theoretical work offers competing explanations of corporate charitable
giving—a profit maximization model
and a manager’s utility maximization
model (Clotfelter, 1985; Navarro,
1988a). As explained in the following
section, the two models differ in the
role of federal tax policy in determining
the level of corporate giving. The profit
maximization model predicts no relation
between the corporate tax rate and the
level of giving. In contrast, the utility
maximization model predicts either a
positive or negative relation, depending
on whether contributions are limited by
a binding minimum profit constraint.
Previous empirical work examining the
motivations for corporate giving
provides mixed evidence on the effect of
tax rate. The previous work is limited in
a number of ways, especially in the type
of data used and the proxy measure of
tax rate.
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TAXES AND CORPORATE CHARITY
variables correlated with included
variables. Finally, all known prior studies
use average tax rates, although there is
little disagreement that marginal tax
rate is the appropriate metric. In
contrast, we use firm- and time-specific
estimates of marginal rate.
can reduce other operating, capital, or
regulatory and governmental costs
(Navarro, 1988a). Choice of role is
arbitrary and does not qualitatively
affect predictions.
For simplicity, we confine our discussion
to a demand-stimulating role. The firm’s
saleable output is a function of contributions and other factors of production;
but marginal dollars of contributions
stimulate demand at a decreasing rate,
such that a profit-maximizing level of
contributions exists. The profit-maximizing level of contributions is independent
of marginal tax rate in such a scenario.
Taxes affect the level of maximum
profits but not the amount of giving at
2
which
the maximum occurs. The
intuition here is that, since investments
in both contributions and other factors
2 production are fully deductible,
of
marginal tax rate has no effect on the
optimal investment mix. Whatever mix is
optimal before taxes is also optimal after
taxes.4
The paper proceeds as follows. The
theoretical models of corporate philanthropy and the results of previous
research are discussed in the next
section. The empirical procedures
including the panel data estimation
techniques and the data used in this
study are discussed in the third section.
The results are presented in the fourth
section and a summary and conclusions
are presented in the final section.
THEORY AND PREVIOUS RESEARCH
Models of Corporate Philanthropy and
the Role of Tax Rates
Corporate philanthropy can be modeled
as a profit maximization problem or as a
utility maximization problem. Formal
developments can be found in Clotfelter
(1985) and Navarro (1988a). Essential
elements of these models are described
below.
The independence of contributions and
tax rate in the case of a rate increase is
depicted in panel A of Figure 1. As tax
rate increases, the profits/contributions
frontier shifts downward. However, the
profit-maximizing level of contributions
is unaffected by the shift. To facilitate
comparability with the other panels in
Figure 1, horizontal indifference curves
are depicted with tangencies at the
maxima of the profits/contributions
frontiers. The horizontal nature of the
indifference curves reflects the fact that
contributions generate management
utility only through their influence on
profits; i.e., contributions generate no
utility in their own right.
1
Consider
first a scenario in which
managers maximize profits. For corporate philanthropy to exist in such a
scenario, there must be some relation
1
between
charitable giving and profits,
either through increased revenues or
decreased costs. Giving might, for
example, stimulate demand for the
firm’s output by improving the
company’s public image (Schwartz,
1968). Alternatively, giving might reduce
costs such as those for labor by creating
a more appealing environment for the
firm’s employees who are in turn willing
to work for lower wages (Clotfelter,
1985). Similarly, corporate contributions
A competing explanation of corporate
philanthropy can be developed from
Williamson’s (1967) model of managerial discretionary behavior. In this model,
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NATIONAL TAX JOURNAL VOL. XLIX NO. 2
FIGURE 1. Effects of Rate Increases on Equilibrium Levels of Contributions
Panel A
Effects of Rate Increase on Profit-Maximizing Level of Contributions
3
Panel B
Effects of Rate Increase on Utility-Maximizing Level of Contributions
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TAXES AND CORPORATE CHARITY
Panel C
Effects of Rate Increase with Binding Profit Constraint
separation of ownership and control
leads utility-maximizing managers to
shirk their responsibility of maximizing
firm value by diverting discretionary
profits to utility-generating perquisites.
Discretionary profits are profits beyond
some minimum level demanded by
shareholders. Corporate contributions
can be viewed as a perquisite financed
with discretionary profits. As in the
profit-maximizing model, marginal
dollars of contributions eventually
reduce after-tax profit. But these
marginal dollars continue to add utility.
Ultimately, however, the utility added is
not sufficient to overcome the utility
sacrificed from diminished profit, hence,
a utility-maximizing level of contributions in excess of the profit-maximizing
level. This scenario is portrayed in panel
B of Figure 1. Note that the managers’
indifference curves are convex in
recognition of both contributions and
profits as utility function arguments.
Further, the horizontal line intersecting
the profits/contributions frontier
represents the minimum profit level
demanded by shareholders.
Panel B of Figure 1 also depicts the
impact of a tax rate change on contributions in this scenario. This impact can be
decomposed into income and substitution effects as follows. Consider an
increase in marginal rates from 30 to 40
percent. The increase leads to a negative
income effect owing to the reduction in
discretionary profits available to finance
contributions. In addition, the increase
in tax rate alters the trade-off between
contributions and profits. Before the
increase, the decision to make a
marginal dollar contribution involves
trading the utility of one dollar of
contributions for the utility of $0.70 of
discretionary profits. After the increase,
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NATIONAL TAX JOURNAL VOL. XLIX NO. 2
the decision involves trading the utility
of one dollar of contributions for the
utility of $0.60 of discretionary profits.
This leads to a positive substitution
effect, i.e., a change in the rate at which
contributions are substituted for profits.
Williamson (1967, Appendix 4-A)
provides an analysis of the negative
income and positive substitution effects
and argues that the positive substitution
effect should dominate the negative
income effect such that the relation
between contributions and marginal tax
rate is positive, as depicted in panel B of
Figure 1.5
C of Figure 1) would appear as vertical
lines. Under this assumption, managers’
utility is always maximized at a corner
solution, i.e., where the profits/contributions frontier crosses the non-negative
profit constraint. As tax rate increases,
the profits/contributions frontier falls
and the prechange level of contributions
violates the constraint. Accordingly,
contributions decline in response to the
rate increase. As in the scenario
depicted in panel C of Figure 1, it is the
presence of the binding profit constraint
that leads to this result.6
Summarizing to this point, no relation
between contributions and tax rate is
consistent with profit maximization.
Either a positive or negative relation is
consistent with investment in contributions beyond the profit-maximizing
level. The sign depends on whether the
over consumption of contributions is
disciplined by a binding minimum profit
constraint. A positive sign is consistent
with absence of a binding constraint.
On the other hand, a negative sign is
consistent with a binding constraint.
A positive relation between tax rate and
contributions obtains only if the
minimum profit constraint is not
binding, i.e., the equilibrium is attained
above the minimum profit level, as in
panel B of Figure 1. If, however, the
minimum profit constraint is binding,
i.e., managers’ perquisite consumption
is not unbridled, an increase in tax rate
leads to a decrease in contributions.
Such a scenario is depicted in panel C of
Figure 1. The intuition underlying this
result is that management consumes
perquisites up to the point at which
discretionary profits are exhausted; and
in a high tax regime, discretionary
profits are exhausted earlier than in a
low tax regime. Accordingly, the relation
between tax rate and contributions is
negative.
Previous Research on the Specific
Determinants of Corporate Giving
Although thus far we have focused
exclusively on the role of taxes, corporate charitable behavior clearly is
affected by other factors as well. In this
section, we discuss these potential
determinants of giving and the results of
prior studies that have examined them.
We begin with a discussion of tax rates.
Next, we discuss some nontax determinants of corporate giving.
Navarro (1988a) offers an alternative
formulation of the manager’s decision
problem that also predicts a negative
relation between tax rate and contributions. His formulation excludes discretionary profits from the manager’s utility
function. The idea is that discretionary
profits do not generate utility in their
own right but rather are only a vehicle
by which management finances
preferred consumption; i.e., managers’
indifference curves (if portrayed in panel
Tax Rates
Most prior studies examining the effect
of tax policy on corporate giving include
a price of contributions, i.e., the
complement of tax rate, as a regressor.
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TAXES AND CORPORATE CHARITY
A significant and positive relation
between contributions and tax rates has
been observed with aggregate timeseries data (Schwartz, 1968; Nelson,
1970; Levy and Shatto, 1978; Clotfelter,
1985). However, the results of survey
studies are different. Based on interviews with executives of 229 large
companies, McElroy and Siegfried
(1986) report that over 90 percent of
their respondents considered tax
incentives to have little or no relevance
to the contributions decision.7 In
Navarro’s (1988a) regression results
using firm-specific cross-sectional
data, the coefficient on tax rate is
negative but insignificant at conventional levels.
Nontax Determinants of Corporate
Giving
Besides tax rates, income is the other
variable included most often in empirical
studies of corporate charity. Its inclusion
is important for several reasons. First,
determining the magnitude of income
elasticity of corporate contributions can
shed light on their responsiveness to
various economic phenomena (e.g.,
business cycles), which in turn has
significant policy implications for both
the philanthropic sector and the federal
government (Navarro, 1988b). However,
there is little consensus in the literature
on this issue, with income elasticity
estimates varying considerably across
studies and even within some studies.
Second, income can be viewed as a
proxy for both company scale (size)
and capacity to make gifts, both
important motives to control for in a
model of corporate giving. Finally, the
expected correlation between income
and tax rates warrants its inclusion to
avoid a potential omitted variables bias.
The models described earlier predict
relations between contributions and
marginal tax rates. However, all the
above studies use average tax rates.8
Perhaps this reflects a belief that
marginal and average rates are approximately equal for corporate taxpayers.
Shevlin (1990), however, points out that
the asymmetric tax treatment of gains
and losses can result in marginal rates
quite different from average rates. He
defines marginal rate as the present
value of cash paid to (or received from)
a taxing authority associated with an
incremental dollar of current taxable
income. Thus, the current marginal rate
depends on taxable income in prior and
future years.
Apart from tax rate and income, prior
studies have examined various other
potential determinants of corporate
giving.9 For convenience, these variables
may be classified as germane to the
profit maximization model, the utility
maximization model, and other factors
influencing corporate giving.
The profit maximization model predicts
that firms make contributions only to
increase revenues or decrease costs.
Variables used to capture the revenueincreasing effects of contributions
include advertising, extent of public
contact, and industry structure. Using a
public perceptions rationale, it has been
argued that contributions serve a
purpose akin to advertising, i.e., as a
marketing tool. Thus, attributes of a
firm that determine its propensity to
Shevlin (1990) outlines and illustrates a
simulation procedure for estimating
expected marginal tax rates (see the
third section for a brief description). He
documents significant deviations
between expected marginal rates and
the top statutory rate. Thus, neither an
average rate nor the top statutory rate is
particularly satisfactory as a proxy for
the tax rate which potentially influences
corporate investment decisions.
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advertise, such as a positive company
profile and higher product awareness,
should also cause the same firms to
contribute more than others. Hence, a
positive relation between advertising
expenses and corporate contributions is
hypothesized, and the evidence is
generally consistent with this hypothesis
(Schwartz, 1968; Levy and Shatto,
1978; Maddox and Siegfried, 1980;
Navarro, 1988a).10 Along the same
lines, firms in industries with a high level
of contact with the public (e.g., banking, insurance, retail trade, and food
products) are likely to contribute more
than firms that sell to industrial and
commercial interests. Evidence is
generally consistent with this argument
(e.g., Frey, Keim, and Meiners, 1982;
Burt, 1983; Clotfelter, 1985), although
the argument is not supported by
Galaskiewicz’s (1985) case study of
publicly held companies based in the
Minneapolis–St. Paul area. With regard
to industry structure, it is frequently
argued that the more competitive the
industry in which the firm operates, the
less the firm will give to charity. Murray
(1991) contends that greater competition places more pressure on managers
to adopt a short-term view of expenditures, which rules out extensive contributions.11 The evidence on industry
structure is mixed. Some studies find
that contributions fall as industry
concentration rises (Johnson, 1966;
Bennett and Johnson, 1980), whereas
others find a positive relation (Pittman,
1976; Maddox and Siegfried, 1980;
Navarro, 1988a).
life in those communities, which in turn
may attract a higher quality labor force
or make the existing labor force work
for lower wages. The improved quality
of life may result in other cost savings to
the firm, such as lower insurance costs
due to reduced vandalism. Cost savings
may also be achieved via lower regulatory and governmental costs. Because
most of the cost reductions come via
lower labor costs, however, prior
research has included labor intensity as
an explanatory variable. Results are
mixed. Navarro (1988a) finds a positive
relation, but Galaskiewicz (1985) finds
no association.
On the other hand, empirical utility
maximization models usually include
only tax rate as a regressor. To our
knowledge, only Navarro (1988a) has
used additional variables to test this
explanation. Among them is the debtequity ratio. Following Jensen and
Meckling (1976), Navarro argues that
the suboptimal use of leverage represents an agency cost imposed by utilitymaximizing managers on shareholders.
Accordingly, he posits a negative
relation between the debt-equity ratio
and corporate giving. He also includes a
dummy variable for whether the firm is
owner controlled or manager controlled
under the argument that, if contributions are a discretionary preferred
expenditure, manager-controlled firms
are more likely to contribute. Last, he
includes dividend changes, with the
expectation that an increase (decrease)
in dividends will be associated with a
loosening (tightening) of shareholder
constraints on perquisite consumption.
Evidence regarding the effects of
leverage and dividend changes is
consistent with expectations.
In some cases, the marginal costs of
contributions may reduce the marginal
costs of operation by more than the
amount contributed. For example, labor
costs may be reduced when firms make
contributions in communities in which
they are based.12 The impact of these
contributions is to improve the quality of
Some prior research has also examined
the effect of nonmarket pressures on
corporate giving. In a number of major
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TAXES AND CORPORATE CHARITY
metropolitan cities in the United States,
business leaders committed to philanthropy have formalized these pressures
through “tithing clubs.”13 Membership
in these clubs requires the firm to
pledge a certain percentage of its net
income (typically, two to five percent) to
charity. Though membership is not
mandatory in order to do business in
cities with tithing clubs, firms failing to
join risk negative publicity and possible
backlash from their customers. Whereas
Navarro (1988a) finds evidence of a
strong positive relation between giving
and the presence of tithing clubs in
cities where the firm is headquartered,
Freeman (1991) finds mixed results for
the tithing club variable.14 Even where
no formal or organized pressure
mechanisms exist, there is evidence that
corporate giving is positively impacted
by the influence of peer group comparisons (e.g., Harris and Klepper, 1976;
McElroy and Siegfried, 1986). Specifically, corporate giving appears to be
highly correlated with the CEO’s own
giving and the affiliation of the firm’s
CEO and other top executives and
directors with specific charities (e.g.,
Yankelovich, Skelly, and White, 1982).
require survey data (e.g., the personal
beliefs and involvement of top executives in philanthropic work). The extent
of any resulting omitted variables
problem is likely to be minimal for two
reasons. First, some of these variables
(e.g., presence of tithing clubs and
personal beliefs and involvement of top
executives in philanthropic work) are
likely to be uncorrelated with tax rate.
Second, the other variables (e.g.,
industry structure, extent of public
contact, and manager/owner control)
that could be correlated with tax rate
are likely to remain relatively constant
over short time periods,15 in which case
their effects can be accounted for by
panel data estimation procedures
discussed in the next section.
EMPIRICAL PROCEDURES
Data and Variable Definitions
As described above, our primary analysis
contemplates firm-specific, longitudinal
data on individual company giving,
marginal tax rate, and income. We
obtained data on firm-level corporate
contributions from Public Management
Institute’s (PMI) Corporate 500: The
Directory of Corporate Philanthropy for
various years. Based on an annual
survey of large U.S. corporations, the
directories include reports on the 500
corporations that are “most active” in
philanthropy.16,17 These data are
compiled from extensive research of
published information including annual
reports, proxy statements, and contributions program publications, as well as
direct contact with company executives.
For corporations with foundations, data
are also obtained from IRS Forms 990PF. For public utilities, the Federal Energy
Regulatory Commission Form 1 reports
are examined. The data compiled from
the various sources are then sent to the
individual corporations for verification.
Although the above is not a comprehensive review of the literature on the
determinants of corporate giving, it is
representative of the type of variables
used frequently to explain why corporations give to charity. While the primary
variables of interest in this study are tax
rates and income, we include in
supplemental analysis some of the
above variables (e.g., advertising, labor
intensity, and debt-equity ratio) that are
motivated by both the profit maximization and the utility maximization models
of corporate giving and that are
observable and available in archival data
for our sample firms. However, we do
not include some of the other variables
that are either not observable or that
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NATIONAL TAX JOURNAL VOL. XLIX NO. 2
Although the Corporate 500 directory
provides one of the most complete data
sets on individual firms’ annual contributions over time, it is by no means
perfect. For example, the same firms do
not appear every year, making it difficult
to perform longitudinal analyses. We made
diligent efforts on our own to obtain the
missing data by contacting firms directly.
In cases in which marginal rate is
uncertain and therefore is characterized
as an expectation, the procedure
simulates multiple sequences of future
taxable income and computes a present
value of incremental taxes for each
sequence. Estimated marginal rate is the
expected value of the resulting present
values. A random walk with drift
process is assumed as the taxable
income generator, and the firm-specific
drift parameter and process variance are
estimated using historical data.
Estimates of each firm’s marginal tax
rate were obtained using Compustat
data and a simulation procedure
discussed by Shevlin (1990). The
procedure estimates the present value
of incremental taxes owing to a one
dollar increase in current taxable
income. Consider a firm with a current
loss and no carryforward from a prior
year. For such a firm, an incremental
dollar of current taxable income (loss
reduction) reduces the refund of prior
taxes by the loss year’s statutory rate.
Thus, the current marginal rate is the
loss year’s statutory rate. Not so for a
firm with a carryforward from a prior
year and either current positive taxable
income or a net operating loss. In such
cases, the present value of incremental
taxes associated with an incremental
dollar of current taxable income (or loss
reduction) depends on when the
carryforward is ultimately realized. Since
the timing of future taxable income is
uncertain, marginal rate is also uncertain and is characterized in terms of an
expected value. The marginal rate is
uncertain even for a firm with positive
current income and no carryforward
from a prior year, because there is some
probability that such a firm will have a
net operating loss during the forthcoming three years, rendering the current
year one to which a loss can be carried
back. Accordingly, there is some
probability that an incremental dollar of
current taxable income will increase the
present value of future tax payments by
less than the current statutory rate.
Following Navarro (1988a, 1988b),
income was measured as pretax income
and obtained from Compustat. To test
the sensitivity of the income elasticity
estimates, we also used other definitions of income (e.g., cash flow from
operations).
As mentioned before, for supplementary
analysis, we also obtained data from
Compustat on other explanatory
variables that were suggested primarily
by Navarro (1988a). These variables
(with definitions in parentheses) were
advertising intensity (ratio of advertising
expenses to sales); labor intensity (ratio
of labor and related expenses to cost of
goods sold); debt-equity ratio; change in
dividends; and return on assets (ratio of
pretax income to total assets). As
discussed briefly before and described
more fully by Navarro, both advertising
and labor intensity surrogate for profit
maximization motives, whereas the
debt-equity ratio and change in dividends capture managerial discretion
motives. Return on assets was included
following Clotfelter’s (1985) expectation
that more profitable firms contribute
more.
Sample Firms and Descriptive Statistics
We had complete data on contributions,
tax rates, and income for 212 firms for
each of the five years 1984–88, result202
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TAXES AND CORPORATE CHARITY
ing in 1,060 firm-year observations.18
Descriptive statistics relating to contributions, marginal tax rate, and income
appear in the three panels of Table 1.
Panel A relates to all 1,060 firm years,
panel B relates to only the 109 firm
years in which income is negative,
and panel C relates to firm years not
involving negative income. As expected
given our data source, the sample
firms are large: panel A shows that
average income is about $694 million
and the average contribution is over
$6 million annually. The sample firms’
average marginal tax rate is 35.3
percent and ranges from zero to the
46 percent maximum statutory rate
during the study period.
TABLE 1
DESCRIPTIVE STATISTICS OF CONTRIBUTIONS, NATURAL LOGARITHM OF CONTRIBUTIONS, INCOME, AND
MARGINAL TAX RATE (FOR 212 SAMPLE FIRMS FOR THE FIVE-YEAR PERIOD 1984–88)
Panel A: All Firm Years (n = 1,060)
Variable
Mean
Std. Dev.
Skewness
Minimum
Maximum
CONT
LCONT
INCOME
RATE
6.120
0.960
693.890
0.353
14.367
1.191
2086.200
0.112
7.849
0.434
–6.772
–1.321
0.051
–2.976
–43,100.000
0.000
189.200
5.243
15,100.000
0.460
Maximum
Panel B: Firm Years Involving Net Operating Losses (n = 109)
Variable
Mean
Std. Dev.
Skewness
Minimum
CONT
LCONT
INCOME
RATE
4.679
0.941
–989.680
0.210
6.754
1.025
4,249.100
0.194
3.085
0.643
–9.084
0.272
0.507
–0.679
–43,100.000
0.000
36.500
3.597
–0.556
0.460
Panel C: Firm Years Not Involving Net Operating Losses (n = 951)
Variable
Mean
Std. Dev.
Skewness
CONT
LCONT
INCOME
RATE
6.286
0.962
886.850
0.369
14.988
1.209
1561.000
0.084
7.648
0.416
5.304
–0.788
Minimum
0.051
–2.976
0.080
0.083
Maximum
189.200
5.243
15,100.000
0.460
Panel D: Year-by-Year Means (Standard Deviations in Parentheses) of Variables for Firms Not Involving Net
Operating Losses (Total Firm Years = 951)
1984
(n = 195)
1985
(n = 180)
CONT
5.221
(13.483)
6.466
(17.300)
6.505
(17.301)
6.576
(14.470)
6.685
(13.242)
LCONT
0.772
0.951
1.018
1.035
1.036
823.829
(1535.080)
909.302
(1821.310)
809.681
(1217.490)
846.360
(1387.880)
1045.960
(1775.720)
0.400
(0.077)
0.403
(0.077)
0.397
(0.081)
0.345
(0.076)
0.303
(0.058)
Variable
INCOME
RATE
1986
(n = 184)
where
CONT = total charitable contributions (in millions of dollars),
LCONT = natural logarithm of CONT,
INCOME = pretax income (in millions of dollars), and
RATE = marginal tax rate based on Shevlin’s (1990) estimation procedure.
203
1987
(n = 200)
1988
(n = 192)
National Tax Journal
Vol 49 no. 2 (June 1996) pp. 193-213
NATIONAL TAX JOURNAL VOL. XLIX NO. 2
million) are only slightly higher.21 Note
that the distribution of contributions is
very right skewed (skewness coefficient
of 7.65 millions in panel C). Also note
that a natural logarithm transformation
produces a contributions variable that is
considerably more symmetric (skewness
coefficient of 0.42 million). Accordingly,
we used the natural logarithm of
contributions as the dependent variable
in the regression analysis. Panel D
reports the data in panel C disaggregated by year. Consistent with expectations, marginal rate declines in postTRA86 years. Moreover, the decline is
not accompanied by a corresponding
decline in income.
Even among our sample of large firms,
approximately 10 percent of the firm
years involve a net operating loss. As
shown in panel B, the average income
in loss years is negative $990 million.
Despite losses, contributions average
only slightly less than the amount for all
firm years. Marginal tax rate averages
21 percent in loss years and ranges from
zero to the 46 percent maximum
statutory rate.
Recall that the three models of the
relation between contributions and
taxes are single-period models that
contemplate positive income. As such,
they are not particularly appealing for
loss years. Consider, for example, the
scenario in which contributions and
marginal tax rates are negatively related.
It seems implausible that firms would
increase contributions when marginal
tax rates are low due to a net operating
loss. In addition, our procedure for
estimating marginal rates is not well
suited to net operating loss firms with
carryforwards. Recall that our marginal
rate estimate for such firms obtains
from simulated sequences of future
taxable income. Unless the variance of
the assumed random walk process is
large, simulated future values following
a net operating loss tend also to be net
operating losses. Such a prolonged
sequence of net operating losses is
not very realistic.19 Accordingly, in panel
C, we present descriptive statistics for
only the 951 remaining firm years that
do not involve a net operating loss
and use these observations to estimate
our regression models (discussed
below).20
Panel Data Estimation Procedures for
Linear Models22
It is well known that a simple pooled
cross-sectional time-series model
relating, say, corporate contributions to
a vector of explanatory variables and
estimated using ordinary least squares
(OLS) will not provide consistent
parameter estimates if unobserved firmspecific characteristics have a unique but
constant impact on giving. In that case,
the simple pooled model suffers from an
omitted variables bias. A fixed-effects
model (FEM) overcomes this problem by
accounting for individual firm heterogeneity via firm-specific constants (intercepts) in the model. These constants
capture the effects of unobserved firm
characteristics that vary by firm but are
relatively stable over time for a given
firm. However, an important limitation
of the FEM is that it produces estimates
that are conditional or sample-specific,
and thus inferences from the FEM are
not generalizable to observations
outside the sample. This shortcoming
can be overcome by a random-effects
model (REM), which views the individual-specific characteristic as a
normally distributed random variable.
As would be expected, both the average
income ($887 million) and the average
marginal tax rate (36.9 percent) are
much higher for the positive income
observations than for the full sample,
whereas average contributions ($6.29
204
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TAXES AND CORPORATE CHARITY
Although inferences from the REM are
generalizable to observations outside
the sample, the REM has its own
limitations. The most significant
limitation is that the REM assumes that
the individual-specific effects are
uncorrelated with the regressors, which
is often hard to justify. As discussed in
the next section, we estimate all three
models: the simple-pooled OLS, the
FEM, and the REM.
first with an evaluation of the model
specification and then discuss the results
for the explanatory variables.
The test statistics indicate that both the
FEM and the REM outperform the
simple-pooled model—the χ2 statistic
associated with the likelihood ratio test
of the equality of the FEM and the
simple-pooled model is 2,164.7 and the
χ2 statistic associated with the Lagrange
multiplier test of the equivalence of the
REM and the simple-pooled model is
1,081.2, which are both significant at α
< 0.0001.23 Further, the Hausman χ2
statistic that tests whether individual
specific effects are correlated with the
regressors is 95.1 (significant at α <
0.0001), which implies that the FEM is
RESULTS
Results of simple-pooled, FEM, and REM
regressions of the natural logarithm of
contributions on marginal tax rates and
the natural logarithm of income appear
in the three panels of Table 2. We begin
TABLE 2
RESULTS OF SIMPLE-POOLED, FIXED-EFFECTS, AND RANDOM-EFFECTS REGRESSIONS OF THE NATURAL
LOGARITHM OF CORPORATE CONTRIBUTIONS ON MARGINAL TAX RATE AND THE NATURAL LOGARITHM
OF INCOME (n = 951 FIRM YEARS)
Panel A: Simple-Pooled Regression Estimates
Variable
RATE
Ln (INCOME)
CONSTANT
Coefficient
Std. Error
t-ratio
Prob. value
–2.216
0.579
–1.739
0.391
0.027
0.196
–5.663
21.587
–8.855
<0.0001
<0.0001
<0.0001
F-statistic (2,948) = 233.666.
Adjusted r2 = 0.329.
Panel B: Fixed-Effects Regression Estimates
Variable
RATE
Ln (INCOME)
Coefficient
Std. Error
t-ratio
Prob. value
–1.032
0.091
0.224
0.022
–4.599
4.417
<0.0001
<0.0001
Std. Error
t-ratio
Prob. value
0.217
0.020
0.109
–6.003
8.201
10.889
<0.0001
<0.0001
<0.0001
F-statistic (213,737) = 46.852.
Adjusted r2 = 0.911.
Panel C: Random-Effects Regression Estimates
Variable
RATE
Ln (INCOME)
CONSTANT
Coefficient
–1.303
0.167
1.190
r2 = 0.163
where
RATE = marginal tax rate based on Shevlin’s (1990) estimation procedure, and
Ln (INCOME) = natural logarithm of pretax income.
205
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NATIONAL TAX JOURNAL VOL. XLIX NO. 2
the superior specification relative to the
REM. Hence, in the subsequent discussion, we focus exclusively on the results
of the FEM reported in panel B of Table 2.
Turning to the results for income, we
find that the coefficient estimate is
statistically significant and positive; i.e.,
increases in income are associated with
an increase in contributions. Given our
use of a double logarithmic regression
model, the parameter estimate of
income is interpretable as its elasticity.
As shown in panel B of Table 2, elasticity
is a low 0.09. To test the sensitivity of
the elasticity estimates to the definition
of income used, we re-estimated the
regression models with three other
measures of income: after-tax book
income, pretax cash flow, and after-tax
cash flow; the estimated income
elasticities were 0.04, 0.17, and 0.13,
respectively. 25
The FEM fits the data well—the adjusted r2 is 0.911, which is consistent
with our expectation of the importance
of effects that vary across firms but are
constant over time. The likelihood ratio
χ2 statistic associated with the test of
the equivalence of the FEM model and a
simple ANOVA model with only fixed
effects is 35.2 (α < 0.0001), implying an
incremental role of marginal tax rate
and income in explaining contributions.
This is confirmed by two-tailed tests of
the hypotheses that the coefficients of
marginal tax rate and income are
nonzero (α < 0.0001).
Our income elasticity estimate is similar
only to Levy and Shatto’s (1978)
estimate of 0.03, but is lower than most
other studies, in which estimates have
varied from 0.44 using aggregated
cross-sectional data (Schwartz, 1968), to
0.54 using aggregated time-series data
(e.g., Clotfelter, 1985), to 0.85 using
firm-level cross-sectional data (Navarro,
1988b). There are several factors that
may bear on the diversity of these
estimates. First is the type of data used.
Clotfelter contends that among estimates based on aggregated data, the
cross-sectional estimates are more
dependable because of the greater
income variability. However, firm-level
data may generate more precise
estimates than aggregated data and
arguably panel data estimates are likely
to be more reliable than cross-sectional
estimates for the reasons mentioned
earlier. Second, Navarro suggests that
the reliability of estimates may also
depend on the choice of regressors in
the model. Levy and Shatto’s low
estimate has been criticized on the
grounds that their model included
dividends and income, which are highly
correlated with each other (Bennett and
The coefficient estimate of marginal tax
rate is negative and significant at (α <
0.01). This result differs from the
positive relation between contributions
and tax rates found in the prior studies
using aggregate time-series data
(Schwartz, 1968; Nelson, 1970; Levy
and Shatto, 1978; Clotfelter, 1985) and
from the nonsignificance of the tax rate
variable in Navarro’s (1988a) study using
firm-specific cross-sectional data. This
result has important implications. First,
the significance of tax rate is inconsistent with the view that corporate
managers engage in charitable giving
solely because giving affects firm profits
through enhanced revenues or reduced
costs. Rather, the significance of tax rate
suggests that corporate contributions
are a source of management utility in
their own right; i.e., contributions are a
form of perquisite in which utilitymaximizing managers overinvest.
Second, the negative sign of the tax rate
coefficient suggests that contributions
beyond the profit-maximizing level are
limited by a binding minimum profit
constraint.24
206
National Tax Journal
Vol 49 no. 2 (June 1996) pp. 193-213
TAXES AND CORPORATE CHARITY
Johnson, 1980). However, our observed
correlation between dividends and
income is only 0.20.
ing our prior finding of a negative
relation, we nonetheless estimated a
model with a one-year-ahead rate
because our data span a period during
which statutory tax rates were changing
in an anticipated way (widespread
publicity was given to rate reduction as
being one of the central features of the
TRA86).
To evaluate the robustness of the above
results, we re-estimated the effect of tax
rate on contributions including NOL firm
years. The sign and significance of tax
rate were qualitatively unchanged. We
also estimated a two-way FEM with
time- and firm-specific effects. It did not
outperform the one-way FEM.
As before, the model specification tests
revealed that both the FEM and the
REM significantly outperformed the
simple-pooled model and that the FEM
was the superior specification relative to
the REM. As shown in the first two
columns of Table 3, despite the inclusion
of the one-year-ahead tax rate, the
contemporaneous tax rate remains
significant and negative as before.
Although the one-year-ahead rate is
significant and negative in the FEM
specification, it is not significant in the
REM.
Supplementary Analysis
We estimated two additional sets of
regression models. One set included the
one-year-ahead tax rate as an additional
regressor. The second set included
advertising intensity, labor intensity,
debt-equity ratio, change in dividends,
and return on assets (in addition to the
one-year-ahead tax rate) as additional
regressors. Results of the analyses are
summarized in Table 3. Note that the
inclusion of the one-year-ahead tax rate
causes a reduction in the sample size
because the last year of the panel
(1988) is unusable.
The last two columns of Table 3 present
the results of regression models estimated with the addition of advertising
intensity, labor intensity, debt-equity
ratio, change in dividends, and return
on assets as regressors. Again, the
model specification tests reveal that the
FEM fits the data best. In the FEM
results, the coefficients of the tax rate
and one-year-ahead tax rate variables
are negative as before, but their
significance levels are diminished. To
further examine this result, we performed an incremental F-test of whether
these additional variables provide any
incremental explanatory power to the
FEM model beyond that provided by the
model including only tax rate, the oneyear-ahead tax rate, and income as
regressors. As shown in Table 3, the
adjusted r2 increases from 0.907 to
0.908 for the larger model; but this
increase is not statistically significant at
any reasonable level. This result is
Motivation for including the one-yearahead tax rate stems primarily from
studies examining the price elasticities of
contributions by individual taxpayers
(e.g., Broman, 1989; Barrett, 1991) and
from an attempt to capture dynamic
aspects of the contribution decision.26
However, unlike individual taxpayers for
whom not all expenditures are tax
deductible, essentially all corporate
expenditures are deductible. One
scenario in which a known tax rate
decrease might influence a corporation’s
current giving is when a prepayment of
contributions can be made without
diminishing future benefits. However, in
such a scenario, the relation between
current tax rate and current contributions should be positive. Notwithstand207
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NATIONAL TAX JOURNAL VOL. XLIX NO. 2
TABLE 3
COEFFICIENT ESTIMATES FROM FIXED-EFFECTS AND RANDOM-EFFECTS REGRESSION MODELS OF CORPORATE
CONTRIBUTIONS (n = 759 FIRM YEARS; t-STATISTICS IN PARENTHESES)
Dependent Variable: Natural Logarithm of Corporate Contributions
Variable
FEM
REM
FEM
REM
RATE
–0.757
(–2.02)
–1.732
(–5.09)
–0.590
(–1.537)
–1.628
(–4.76)
RATE[+1]
–0.407
(–2.12)
–0.099
(–0.54)
–0.375
(–1.92)
–0.064
(–0.34)
Ln (INCOME)
0.064
(2.03)
0.208
(7.70)
0.073
(2.23)
0.225
(8.07)
ADVER
—
—
—
—
13.636
(2.86)
5.219
(3.01)
LABOR
—
—
—
—
0.038
(0.15)
0.354
(1.92)
DERATIO
—
—
—
—
–0.43 × 10–6
(–0.05)
0.84 × 10–5
(1.09)
ROA
—
—
—
—
–0.49 × 10–2
(–1.18)
–0.57 × 10–2
(–1.48)
DDIVSH
—
—
—
—
–0.011
(–1.18)
–0.016
(–1.51)
CONSTANT
—
—
0.370
(2.24)
—
—
0.144
(0.83)
R-squared
0.907
0.196
0.908
0.232
where
RATE = marginal tax rate based on Shevlin’s (1990) estimation procedure,
RATE[+1] = one-year-ahead marginal tax rate (RATEt+1),
Ln (INCOME) = natural logarithm of pretax income,
ADVER = advertisement expenses/sales,
LABOR = labor and other expenses/cost of goods sold,
DERATIO = debt-equity ratio,
ROA = return on assets (income/total assets), and
DDIVSH = change in dividends per share.
consistent with our earlier arguments
that these firm-specific characteristics
are unlikely to vary much over short
periods of time, and hence their effects
would be accounted for by the FEM.
Econometrically, including these
variables in the FEM is akin to the
addition of irrelevant explanatory
variables in a regression model (i.e.,
ignoring the restriction that those
coefficients are zero). As is well known,
the consequence of this specification
error is that regression coefficients of
the relevant variables are unbiased but
inefficient (e.g., Kmenta, 1986). In any
event, note that the coefficients of these
variables are generally similar to the
smaller FEM presented in the first two
columns of Table 3.
Summary and Conclusions
In summary, an empirical model that
describes corporate giving in terms of a
firm-specific fixed effect and an effect
due to marginal tax rate and income is
well specified. The existence of the
marginal tax rate effect is inconsistent
with a profit-maximizing level of
contributions and consistent with giving
208
National Tax Journal
Vol 49 no. 2 (June 1996) pp. 193-213
TAXES AND CORPORATE CHARITY
beyond the profit-maximizing level.
Moreover, the negative relation between
giving and marginal tax rate is consistent with a scenario in which managers
are subject to some market discipline.
The result suggests that corporate
charity is not greatly impacted by
variations in business cycles and that
nonprofit organizations are not as
vulnerable during recessionary times as
previously considered (Navarro, 1988b).
The sustained level of giving during the
late-1980s, regarded by some as the
beginning of a recessionary period,
reinforces the above finding.
The negative empirical relation between
giving and marginal tax rate also has a
tax policy implication. It transforms any
debate about additional limitations on
the deductibility of corporate contributions into a debate about monitoring
costs. Shareholder tolerance of contributions beyond the profit-maximizing level
presumably arises as a result of costs of
monitoring managers’ behavior.
Arguments favoring substitution of a
statutory constraint for a market-based
constraint would seemingly turn on
whether the costs of enforcing the
market-based constraint are “too high.”
The results of this study are subject to at
least two caveats. First, use of panel
data raises the possibility of attrition
bias in that only surviving firms are
included in the sample. However, given
that our sample consists of large firms,
the extent and severity of this problem is
unclear. Second, our analysis indicates
support for the FEM, inferences from
which typically are not generalizable
outside the sample. However, the
sample used in this study consists of
large firms that were most active in
philanthropy, and the evidence suggests
that such firms do most of the giving in
the United States. Furthermore, the
inferences are unchanged based on the
more generalizable REM. Thus, the
model limitations may be of little
practical importance.
The empirical result also has indirect
implications for other forms of perquisites and speaks in favor of more
extensive disclosure of managerial
compensation in reports to shareholders, a matter of considerable controversy
currently. For example, the tax reform
proposals recently enacted include a
limitation on deductibility of excess
executive compensation. Similarly, the
Securities and Exchange Commission
mandated more expansive reporting in
proxy statements to facilitate more
informed shareholder assessments of
executive compensation. Further, the
Financial Accounting Standards Board
recently promulgated a standard
requiring pro forma disclosure of net
income as if the fair value of stockbased compensation were recognized as
expense, despite vigorous opposition by
some members of the Business
Roundtable (Cowan, 1992).
ENDNOTES
1
The result that corporate contributions
are relatively inelastic has important
implications for the philanthropic sector.
209
This paper has benefited greatly from the detailed
comments of two reviewers, Joe Anthony, Terry
Shevlin, Roxanne Spindle, Chuck Swenson, Gary
Weber, Ph.D. seminar participants at the University
of Waterloo (Alan Macnaughton and Gordon
Richardson, Supervisors), and the suggestions of
participants in the School of Accountancy
Workshop at Arizona State University, particularly
Hal Reneau and Larry Grasso. Finally, the capable
research assistance of Carol Johnson is gratefully
acknowledged. All remaining errors are, of course,
ours. An earlier version of this paper was
presented at the 1994 Annual Meeting of the
American Accounting Association.
See American Association of Fund-Raising Counsel’s
AAFRC Trust of Philanthropy’s publications (various
years) and as recently quoted in the Wall Street
Journal (November 26, 1993, p. A1).
National Tax Journal
Vol 49 no. 2 (June 1996) pp. 193-213
NATIONAL TAX JOURNAL VOL. XLIX NO. 2
2
Corporate contributions have been deductible for
tax purposes since 1936. However, the deduction
was subject to two major limitations. First, the
deduction was disallowed (and was illegal per se) if
the contributions did not yield a “direct benefit” in
terms of increased profit to the corporation. This
direct benefit doctrine applied until as late as
1953. Second, the deductions were limited to five
percent of net income before contributions and
several other items. The Economic Recovery Tax
Act of 1981 raised this limit to ten percent [IRC §
170(b)(2)]. The deduction of contributions as a
trade or business expense continues to remain
specifically prohibited under IRC § 162(b). See
Fremont-Smith (1972) for a historical perspective
on the deduction and Clotfelter (1985) for other
details on the tax treatment of corporate
contributions.
3
The IRS data generally are available in the Statistics
of Income series. To overcome the problems
caused by aggregation, some studies have used
data from the Source Book of Statistics of Income,
which provides a two-way classification of firms by
industry and size (e.g., Johnson, 1968; McElroy
and Siegfried, 1985). Although this classification
scheme reduces the level of aggregation and
allows for greater variation within industries in
estimating the profits/contributions relationship,
the problems with aggregation remain.
4
This is unlike the case involving individual
taxpayers, for whom not all expenditures are
deductible. In such a case, the tax rate affects the
feasible trade-off between contributions and
nondeductible expenditures and, hence, their
optimal mix. The assumption that corporate
contributions are fully deductible for tax purposes
is reasonable, since the current ten percent of
net income ceiling on deductibility is seldom
reached.
5
Proof can be obtained via appropriate restrictions
on either the manager’s utility function or the
relation between profits and contributions. See
Williamson (1967, Appendix 4-A) and Clotfelter
(1985).
6
We thank an anonymous reviewer for significantly
enhancing our understanding and the intuition
underlying the negative relation between
contributions and tax rates. This reviewer also
suggested one other scenario in which such a
relation can obtain. It is possible for the negative
income effect to outweigh the positive substitution effect at lower levels of profits that would
result with a tax rate increase. The intuition here
is that, at these lower profit levels, managers may
be less willing to trade-off profits for contributions,
resulting in a large negative net effect. Thus, a
negative relation between tax rates and
contributions can exist even in the absence of a
binding profit constraint, a possibility mentioned
by Williamson (1967).
7
Similarly, based on interviews with CEOs of major
U.S. corporations, Yankelovich, Skelly, and White
(1982) report that nearly half of their respondents
stated that taxes have no effect on giving
decisions. An additional 36 percent stated that
taxes have “some” effect.
8
Nelson (1970) is perhaps an exception in that he
attempts to estimate marginal tax rates for
aggregated industry-level data. However, Clotfelter
(1985) points out several weaknesses in Nelson’s
tax rate measure, which simply results in the top
statutory rate for most years and, in all cases,
produces only one rate per year. Clotfelter makes
elaborate efforts to overcome Nelson’s limitations
by calculating marginal tax rates for mean incomes
within each asset class by year and applying the
corporate tax schedules to the tax bases in each
class. Because Clotfelter also uses the same
aggregated data, he recognizes that even his
marginal rates “will tend to mask some variation in
the actual marginal tax rates faced by individual
corporations” (p. 208). Further, while acknowledging that “the correct measure of a company’s price
is based on its marginal tax rate” (p. 211), he
suggests that average tax rates may be more appropriate with aggregated data because “they may be
a better measure of the average of marginal rates
than the calculated marginal rate” (p. 213).
9
See Clotfelter (1985) and Murray (1991) for
literature reviews.
10
Some maintain the sign on the coefficient of
advertising is ambiguous, because contributions
may serve either as a complement or as a
substitute for advertising (Schwartz, 1968).
However, Navarro (1988a, p. 78, footnote 25)
contends that the coefficient sign cannot resolve
the issue because “the concepts of gross
substitutability and complementarity have to do
with the cross-price elasticity, which the parameter
estimate sheds no light on.”
11
Johnson (1966) presents a slightly different
argument that distinguishes “rival” or oligopolistic
firms from competitive and monopolistic ones. He
contends that rival firms will give more to charity
because their market share is likely to be more
sensitive to public perception, whereas competitive
firms cannot afford to and monopolistic firms have
no need to influence public perception.
12
Survey data provide strong evidence that corporate
giving tends to be concentrated in cities in which
firms are headquartered and in other areas in which
firms’ operations are located (McElroy and Siegfried,
1986; Yankelovich, Skelly, and White, 1982).
13
Cities with tithing clubs include Baltimore, Denver,
Duluth, Jacksonville, Kansas City, Louisville,
Minneapolis–St. Paul, Phoenix, Rochester, San
Francisco, Seattle, Tuscaloosa, and St. Cloud
(Navarro, 1988a; Freeman, 1991).
14
Freeman (1991, p. 20) notes that there may be a
selectivity problem at work: “companies in cities
210
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Vol 49 no. 2 (June 1996) pp. 193-213
TAXES AND CORPORATE CHARITY
where tithing clubs thrive give more than other
companies, but for some latent reason that also
underlies the formation of the clubs in the first
instance.”
15
Navarro (1988b) also provides empirical support for
this contention. Using firm-specific data, he
regresses the log of contributions on the log of
income to estimate the income elasticity of
corporate contributions. He finds that the elasticity
estimates are unchanged even with the inclusion
of such variables as labor intensity and advertising
expenses in the model.
16
Although not mentioned in the directory, one of
the authors was told in a telephone interview with
PMI that a firm had to contribute at least $0.5
million in order to be included in the directory.
However, some companies were included even if
they gave less than the minimum cut-off amount,
provided they gave more in the other years
included in the directory.
17
Limiting the initial sample to the population of
large firms potentially results in a truncated
sample. This causes OLS estimators to be biased
and inconsistent and requires the use of truncated
regression. However, truncation is not viewed to
be a problem when studying corporate giving,
because there is a preponderance of evidence that
large corporations do most of the giving in the
United States. For example, the largest 0.5 percent
of all corporations account for over 75 percent of
all corporate contributions (Clotfelter, 1985; IRS,
1988). Empirically, Navarro (1988a) found virtually
identical results using OLS and truncated
regression.
18
Data on advertising and labor expenses were
missing for several of the firms. In the supplementary analysis that included these variables, they
were coded zero to minimize loss of observations.
19
Of our sample of 212 firms, five had three
consecutive loss years, one had four consecutive
loss years, and none had five consecutive loss
years.
20
This is also consistent with most of the prior
research, which includes only firms with positive
net income (Clotfelter, 1985).
21
Note that even for firm years with only positive
income, the average marginal tax rate of 0.369 is
less than the weighted average top statutory rate
of 0.423 for the five years. This difference is
statistically significant with the computed Zstatistic of 19.93 (α < 0.0001). This suggests that,
even for large firms with positive taxable income,
there is some nonzero probability of a loss in the
future, which makes the use of the top statutory
rate inappropriate as the marginal tax rate
measure. As a further internal consistency check of
our marginal rate estimation procedure, we
examined descriptive statistics by year. As
expected, the mean marginal rate for our sample
declined in the post-TRA86 period. Specifically, the
average marginal rates in the five years 1984–88
were 0.400, 0.403, 0.397, 0.345, and 0.303,
respectively. Each of these sample averages is also
significantly less (at α < 0.0001) than the top
statutory rate in those years (0.46 in 1984–86,
0.40 in 1987, and 0.34 in 1988), further
reinforcing the case against using the top statutory
rate as the marginal rate.
22
See Chamberlain (1984) and Hsiao (1986) for reviews.
23
Various statistical tests have been proposed in the
literature to evaluate the adequacy of the model
specification (e.g., Kmenta, 1986; Greene, 1993).
First, both the FEM and the REM can be compared
with a simple-pooled model. The likelihood ratio
test or an F-test allows a test of the null hypothesis
of homogeneity of individual-specific effects (i.e.,
α1 = α2 = . . . = αn) to determine whether the FEM
outperforms the simple-pooled model. Under the
null, the simple-pooled model is the more efficient
estimator. Similarly, the appropriateness of the
REM relative to the simple-pooled model can be
examined with the Breusch and Pagan Lagrange
multiplier (LM) test. Large values of the LM test
statistic (which is distributed as χ2) favor the REM.
Next, the FEM and REM can be compared against
each other using Hausman’s (1978) specification
test, which formally tests whether the random
effects are orthogonal to the regressors. Large
values of the test statistic (which is also distributed
as χ2) favor the FEM.
24
Alternatively, the negative sign can be interpreted
as an indication that the income effect dominates
the substitution effect. A dominant income effect
might occur as the firm experiences adversity and
is more hard pressed to satisfy its minimum profit
constraint, but prior to the constraint becoming
binding (Williamson, 1967).
25
After-tax cash flow is defined as pretax income plus
depreciation and amortization minus taxes. To
make the definition exogenous of the contribution
decision, income is computed before contributions
and taxes are calculated without the deduction for
contributions. Although pretax income has been
the definition of income used most frequently in
previous studies, Clotfelter (1985) has argued that
cash flow is a better measure of income available
to management and a firm’s capacity to give, and
that in any case after-tax quantities are preferable
to before-tax quantities. As one might expect, the
after-tax elasticity estimates are lower than their
counterpart pretax estimates.
26
We thank an anonymous reviewer for suggesting
this additional analysis.
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