As nonprofit organizations, art museums are exempt from federal income tax in the . This exemption does not mean that tax rules have no effect on museums, however. Far from it. The various tax instruments affect art museums indirectly but dramatically. They change the incentives of individuals and corporations to make donations of art, they change the relative cost of raising capital for museum projects, and they change the incentives of museums to make passive investments in securities rather than active investments in unrelated businesses.

Tax policy provides an extra incentive to make charitable donations through the deduction against income tax or estate tax for such gifts.

Under either view, the tax system clearly provides more incentive for charitable gifts than if there were no deduction. If this incentive induces more donations of art, then tax policy affects art museums. This paper will look at measures of this incentive and its effect.

Similarly, the government does not tax the endowment income of charitable organizations like museums. There is no explicit effect, either tax or subsidy. However, taxes levied on the rest of the economy serve to raise the cost of other activities relative to the cost of museum activities. In this sense we say that there is an implicit subsidy. With limited economic resources to go around, a tax system that discourages certain uses of resources necessarily encourages other untaxed uses of resources. The tax system thereby impacts museums. I discuss these implicit subsidies, while the paper by Charles T. Clotfelter (chap. 9 in this volume) discusses explicit government subsidies.

The next section provides an overview of the various forms of indirect federal aid to art museums. It measures the rate of the implicit subsidy, and it provides a rough calculation of the size of the tax expenditure. It briefly discusses the justifications for public support and provides empirical evidence on willingness to pay.

These preliminaries accomplished, following sections attempt to document the actual effects of tax policy on art museums. Section 8.3 discusses the tax rules for individuals' gifts in other countries, provides a brief history of rules in the , and considers the recent reduction of marginal tax rates and the inclusion of appreciated property in the alternative minimum tax. It finds that the reduction of rates in the 1986 Tax Reform Act may depress gifts to art museums by as much as 24 percent. Section 8.4 analyzes incentives provided by the income tax exemption and the unrelated business income tax. It finds that the combination of tax advantages does reduce the cost of capital, but the result is still not unfair to other businesses as long as the rules do not change unexpectedly. This section also discusses rules for gifts of art by firms under the corporate income tax, and bequests of art under the estate and gift tax. A final section offers conclusions.

CONTENTS
Introduction.
Implicit subsidy and tax expenditure.
The deduction for charitable giving.
Other taxes affecting art museums.
Conclusion.
References.
Appendix:
     A. Price elasticities and simulation.
     B. The cost of capital.
Tables:
     8.1 Marginal tax rates and the price of giving to the arts.
     8.2 Willingness to pay extra for arts and culture.
     8.3 The deductibility of donations in OECD countries.
     8.4 The top Federal personal income tax rates in the .
     8.5 Predicted change for individual giving to arts and culture.
     8.6 Unrelated business income and compliance with UBIT.
     8.7 Beneficiaries of corporate support as percent of total giving.

As nonprofit organizations, art museums are exempt from federal income tax in the . This exemption does not mean that tax rules have no effect on museums, however. Far from it. The various tax instruments affect art museums indirectly but dramatically. They change the incentives of individuals and corporations to make donations of art, they change the relative cost of raising capital for museum projects, and they change the incentives of museums to make passive investments in securities rather than active investments in unrelated businesses.