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January 14, 2019

Does government spending crowd out charitable behavior?

Opinion image

Private charitable contributions of time and money play an essential role in most economies. In 2017, private contributions to US charities surged to an estimated $287 billion, rising 5.2% compared to 2016. 

From a policy perspective, there is concern that private charitable donations might be crowded out by comprehensive government spending. If people are only concerned with the total amount of welfare provided, they will treat government spending as a substitute for their own donations. In such a situation, an increase in government spending would result in a one-for-one decrease in private spending, or vice versa. 

The crowding-out hypothesis has important policy implications. On the one hand, policymakers should be concerned that an increase in welfare spending will significantly lower the engagement of nonprofit organizations and private donors. On the other hand, it implies that the private sector will assume more of the responsibility for the provision of social services when the government decreases its level of welfare provision. If this holds true, public spending cuts could be justified based on the idea that the private sector takes over. 

To illustrate the idea of a crowding-out effect, a comparison is often made between the US and Europe. The US, which is characterized by a low level of public welfare provision, is traditionally known for being one of the countries with the highest extents of charitable giving and volunteering worldwide. Europe, in contrast, is characterized by an extensive welfare state and a considerably lower private provision of charitable activities. Consequently, one might jump to the conclusion that extensive welfare states crowd out private charitable behavior.
The evidence on the crowding-out effect, however, is at best mixed. Evidence of large, though incomplete, crowding out has only been established within experimental frameworks. Yet, while laboratory experiments provide helpful insights into the individual motivations behind private giving, the extent to which the observed behavior can be generalized to the world outside the laboratory remains unclear. 

Studies based on micro data on charities, in contrast, usually find small crowding-out effects, while some even find evidence of a crowding-in effect. The crowding-in effect is explained by the fact that government grants serve as a signal of the charity’s high quality, thus inducing private donors to contribute more to that specific charity. 

Evidence of small crowding-out or crowding-in effects is also obtained from studies that use cross-country or regional variation in private and public spending to analyze the effect of the extent of the welfare state on charitable activity. The conclusion that can be drawn from the existing empirical evidence is thus that crowding out exists, but that it is far from being perfect.
Policymakers should therefore acknowledge that public spending influences private spending. However, they should not be too concerned that an increase in government spending largely crowds out private contributions, nor can they count on the fact that a decrease in government spending is automatically compensated for by private giving.

© Julia Bredtmann

Read Julia Bredtmann's full article, “Does government spending crowd out voluntary labor and donations?

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