Charitable deductions for interest-free loans?

Are all charitable donations equal under tax law?

Sarah B. Lawsky, of Southern Methodist University, tackles this question in Money for Nothing: Charitable Deductions for Microfinance Lenders. She looks at Kiva Microfunds, an internet-based microcredit organization that enables users to directly lend to borrowers in poor, underdeveloped countries. These loans provide poor entrepreneurs the capital needed to start businesses or organizations.

Kiva’s lending process: Ordinary individuals like you or me provide interest-free loans through Kiva (a tax-exempt charity), who then goes through local microfinancing institutions to distribute the loans to borrowers. The local institutions add interest to the loans in order to fund their operating costs, whereas Kiva operates on direct donations.

Despite the charity tax status of Kiva, lenders are not eligible for charitable deductions in lieu of foregone interest payments. Lawsky argues that this should be remedied. Her proposal, the deduct-include method, would be consistent with current exemptions to the tax code regarding charitable deductions of partial interests donations and would not result in compliance issues.

Lawsky mentions the objections to charitable deductions, the uncertainty regarding the effectiveness and sustainability of microlending, and evidence that Kiva is successful even without charitable deduction for foregone interest. Yet she concludes that deduction status will allow “loans through Kiva [to] become financially comparable to other charitable donations” and therefore increase the likelihood of sustainability amongst competition. Additionally, the proposed tax reform would show political support for microlending which may shift consumer behavior, potentially increasing the number of participants and their lending amounts.

While I agree with the analysis–as long as charitable deductions exist they should be available for all forms of donations–I am curious about Kiva’s success in the absence of equality. When Lawsky wrote her analysis in August of 2008, Kiva had shown massive popularity and success since their creation in 2005. Through nearly 325,000 different lenders, Kiva provided a total of $38 million in loans at a repayment rate of 98.36%.  Today Kiva’s growth and popularity is even more substantial: roughly 582,000 lenders; over $99 million in loans; and a repayment rate of 97.87%! These numbers show that lenders find value in lending even without interest payments or tax deductions. This value may be, for example, a feeling of benevolence, a sense of community fostered by Kiva, a sense of promoting independence, entrepreneurship, and liberty, or something else all together. It also shows that while the overall effectiveness of microlending is still undetermined, the individuals who receive capital are  at least breaking even if not benefiting from these loans.

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