Why are churches tax exempt in the US? There are several reasons often given, but do these add up to sensible and fair policy?
Growing up in a small town in Michigan in the middle of the twentieth century, I heard this proverb frequently, and it always puzzled me. In elementary school, I earned a weekly allowance by performing household chores like mowing the lawn and drying and putting away the dishes as my mother washed them. My income was a quarter a week, and I usually blew it on candy bars and “pop” as we called carbonated soft drinks back then.
Later, when I was in high school, I worked as a box boy at the local grocery store and spent a good part of my earnings on root beer floats served in frosted mugs at Irv’s Place. After football games, that was the place to go with your date, to feed nickels into the pinball machine and jukebox, and replay the game with teammates. I earned the money that I spent there, whether I saved it or not. On the rare occasions when I saved any, I didn’t earn it again.
There is a well-known proverb:
“A penny saved is a penny earned”
—one form of an old proverb
At the time, the proverb made no sense to me.
Later, I learned that sometimes a penny saved is indeed a penny earned. A business will not survive for long if the income from the goods it produces or the services it provides is exceeded by operating expenses. A well-managed business pays close attention to those expenses. Every penny saved there goes straight to the bottom line, either adding to earnings or subtracting from losses. Operating expenses typically include the costs of labor and materials, equipment and building maintenance, employee benefits and, of course, taxes.
Let’s talk taxes
Taxes are a major expense that most businesses must deal with. But over the years, many loopholes have been opened, allowing especially big multinational corporations to avoid income taxes on much of their income. Although the U.S. has the highest nominal corporate tax rate of any developed nation, 35%, tax breaks and loopholes in the tax law make that rate a fiction. Many corporations pay less than 10%, and some pay zero! Nevertheless, one of the mantras of the Republican political agenda is that corporate tax rates are strangling US companies. When President Trump was in charge, he vowed that one of his first actions would be to cut corporate taxes. His tax reforms did just that.
For nearly a century, oil companies have received a special tax break called the Oil Depletion Allowance. They have avoided paying almost five hundred billion dollars (in today’s dollars) in taxes. The Oil Depletion Allowance was approved by Congress in 1926. Texas Senator Tom Connally, who sponsored it, later admitted, “We could have taken a 5 or 10 percent figure, but we grabbed 27.5 percent because we were not only hogs but the odd figure made it appear as though it was scientifically arrived at.”
Despite numerous attempts to eliminate them, those giveaways to oil companies are still alive and well today. Defenders say that without them, the price of petrochemical products like gasoline would skyrocket, hurting consumers. Think about that for a moment. Do the oil companies, out of the goodness of their capitalist hearts, take pity on US drivers because they get that tax break? A business charges whatever the market will bear for its product. Any CEO who doesn’t do that would be fired. Oil prices are largely determined by international oil markets. Whether an oil company pays taxes or not, the price is what it is.
Of course, if the tax breaks were eliminated, you can be sure that gasoline prices would go through the roof! There is no free market for refined products like gasoline. The big oil companies literally have us over a barrel. But you have to understand: Those extra earnings are needed to give the CEO’s a raise so that they can afford to buy
their yachts, mansions and Rolls Royces food for their starving families on their meager salaries.
But seriously, it’s time to do something about these handouts to corporations. They serve no legitimate purpose, and they starve the government of needed funds for programs that actually would help poor people climb the economic ladder. Isn’t that something we should all support instead of fattening the hogs, as Senator Connally correctly identified them?
Not all businesses pay taxes. Non-profit companies that provide charitable services can attain tax-free status. In order to qualify, they must apply to the IRS. Many categories of non-profit businesses are recognized by the IRS, including all legitimate churches. In fact, churches do not even need to apply to the IRS. They are automatically tax-exempt.
Tax-exempt status saves a business a lot of money, and that money goes straight to the bottom line. Of course, a non-profit company cannot generate net income, so the money that would otherwise be owed to the government in taxes is immediately available for running the business, and it can be used for any purpose.
What is the justification for tax-free status? One argument is that charities provide essential services that would otherwise be provided by the government. Thus, encouraging donations to charitable organizations by making them tax-deductible saves the government money.
There are two problems with this: First, the government has no control over how the money is spent, so it may not address the most urgent societal needs. Second, the government has no control over the amount of money that is spent. Every dollar given to a charity reduces the donor’s tax liability, thereby reducing tax revenue. Unless that revenue shortfall results in equal or greater savings in government expenditures, some combination of reduced government services, increased government debt, or tax increases will be necessary.
Now, consider a for-profit company that is producing, let’s say, electric vehicles (EVs). Initially, the cost of those vehicles is higher than gasoline-burning vehicles, but the government decides that burning less fossil fuel is desirable to reduce environmental pollution and global warming. So, it offers a subsidy to buyers of EVs. This may be in the form of a direct cash rebate to the buyer or a tax credit. In the latter case, the buyer can deduct the amount of the credit from his income tax payment. This benefits the buyer, but it also benefits the EV manufacturer, because it allows them to charge a higher price for the vehicle than would otherwise be possible in order to compete successfully with the gas burners.
So, indirectly that subsidy to the buyer adds to the earnings, or subtracts from the losses, of the EV manufacturer. Usually, such subsidies are temporary interventions, intended to “incubate” new businesses that are deemed beneficial to the general public. The net result of a direct subsidy is very similar to a tax exemption for a business or a tax deduction for an individual, but there is one big difference: The government controls exactly how much money it is spending and exactly how it will be used. Both methods are considered government spending. Exemptions, deductions, and tax credits are called “tax expenditures,” which are defined as:
A tax expenditure program is government spending through the tax code. Tax expenditures alter the horizontal and vertical equity of the basic tax system by allowing exemptions, deductions, or credits to select groups or specific activities.
This is the obverse of the proverb at the top of this piece. So now, let’s restate that proverb as it applies to the 21st century:
A penny saved in taxes adds to the net income of individuals or businesses.
Conversely, a penny that is not collected in taxes adds to the expenditures of the government.
So, a tax exemption, a tax deduction, or a tax credit is equivalent to a direct payment from the government like a subsidy or a rebate. They are just different forms of government spending. Hammer this into your brain. You will see why this is very important in the discussion that follows.
When the government hires a private contractor, cost and technical proposals are invited from qualified companies, and then evaluated to select the winning bid. A contract specifying exactly what is to be done, and at what cost, is signed by both parties. But in the case of tax expenditures for charities, there is no proposal or evaluation, and no contract. The donor selects the charity and decides how much money to contribute. The government supplies its portion as a tax expenditure, a tax deduction to the donor, with little assurance that any worthwhile work will be done, or if it is, at what cost. Is that any way to run a government?
Churches are exempt from both income tax and property tax. Is this a subsidy? In the case of the EV buyer, whether he gets a cash payment or a tax credit, it is called a subsidy. The Oil Depletion Allowance, a tax deduction, is widely acknowledged to be a subsidy. Churches claim that their tax exemptions and the tax deductions their donors receive are not subsidies. But as we have seen, those tax breaks are tax expenditures, a form of government spending. Why would they try to deny that reality?
Because of the Constitution.
The Establishment Clause in the Constitution says “Congress shall make no law respecting the establishment of religion…” Surely, subsidies in the form of direct payments to churches would violate that prohibition. Why don’t tax expenditures violate it? The money that would otherwise be owed in taxes goes straight to the church’s bottom line, as it does for any business, and it can be used for whatever purpose the church deems appropriate. Some of it might be used for charitable work, but churches spend a very small percentage of their income on charity…typically less than 5%. But it can also be used for summer Bible camps, missionary work, or other religion-related activities, including the funding of political causes such as opposition to abortion, contraception, and gay marriage. (Note: My 5% figure is based on statistics from a Christianity Today survey and Roy Sablosky from the board of the American Humanist Association of Greater Sacramento).
The Establishment Clause clearly prohibits the use of government money for religious activities, and government should not be funding political actions by private organizations.
Why are churches exempt?
All of the above raises an obvious question: Why are churches tax-exempt? What benefits do they provide to nonmembers…the general public? If a church wants to run a secular charity, fine; let them apply to the IRS for 501(c)(3) status like all other secular charities, subject to all the same rules as any other charity, including audits. It goes without saying that the finances for that charity should be completely segregated from the church.
Defenders of tax exemptions for churches often quote the Free Exercise clause from the Constitution, claiming that taxing churches would violate the free exercise of religion. All citizens are free to “exercise” whatever religious beliefs they like. That has nothing to do with their church, which is a business providing services to members. Those services are not necessary for the “free exercise” of their beliefs. If they were, then believers should be able to buy mansions, yachts, and Rolls Royces (as some of the televangelists do) and write them off as a tax deduction, claiming that their religious beliefs require those things. Free exercise does not mean a free ride with special privileges. Churches should be subject to the same laws as all other businesses. Government should be completely impartial on this. Whether a business is saving souls or, like Irv’s Place, serving root beer floats, it should be subject to the same laws.
Another argument by opponents of church taxation: The late Rev. Dean M. Kelley, a leading proponent of religious freedom, explained that church members are already taxed on their individual incomes, so “to tax them again for participation in voluntary organizations from which they derive no monetary gain would be ‘double taxation’ indeed, and would effectively serve to discourage them from devoting time, money, and energy to organizations which contribute to the upbuilding of the fabric of democracy.”
A business that provides a service to its customers is taxed on the income that it receives from them. People give money to churches because they receive services that they value as members of the church. How is that different from any other business? To address the final part of Rev. Kelley’s argument, how do the religious functions of a church “contribute to the building of the fabric of democracy?” It’s a vague and meaningless statement. Many church members are uncomfortable with their church getting involved in the political process. James Madison was right about entanglement between churches and government:
Every new & successful example therefore of a perfect separation between ecclesiastical and civil matters, is of importance. And I have no doubt that every new example, will succeed, as every past one has done, in shewing that religion & Govt. will both exist in greater purity, the less they are mixed together. —James Madison
Let’s not confuse matters here
The fabric of democracy that Rev. Kelley refers to should have nothing to do with churches or religion. If churches want to solicit government help in performing charitable services, let them separate those services completely from their religious functions so that the Constitution is not violated, and Madison’s advice is followed.
One final quote by another founder, Benjamin Franklin, and then I will rest my case:
When a religion is good, I conceive it will support itself; and when it does not support itself, and God does not care to support it, so that its professors are obliged to call for the help of the civil power, ’tis a sign, I apprehend, of its being a bad one. —Ben Franklin, Poor Richard’s Almanac, 1754 (Works, Volume XIII)]
Bert Bigelow graduated from the University of Michigan College of Engineering, then pursued a career in electronic systems and software design. He has always enjoyed writing, and since retirement, has produced short essays on many subjects. His main interests are in the areas of politics and religion, and the intersection of the two. You can contact him at email@example.com.