State and local governments rely on nonprofits to deliver most social services, from housing to substance abuse treatment to early childhood education. Now those nonprofits, and their government partners, are concerned that the new tax law passed in December could indirectly slash their funding.

“Nonprofit organizations are an essential part of the health and human services system in this country,” says Candy Hill, a senior director at the American Public Human Services Association. “Anything that weakens their capacity to be a full partner with government has the potential to weaken the entire system.”

In 2010, government agencies had about 200,000 contracts or grants with about 33,000 human service nonprofits across the country. For nonprofits at large, government contracts and grants represent about a third of all funding, the second largest revenue source after fees for service. Charitable giving is the next biggest source, representing 12 percent of nonprofits' funding.    

One of the reasons people give to nonprofits is for the tax benefits. But in order to cash in on the incentives for charitable giving, people have to itemize their deductions instead of claiming the standard deduction. The Tax Cuts and Jobs Act of 2017, however, doubles the standard deduction, making it a more attractive option for middle-income households. The number of households claiming the charitable deduction is expected to shrink from 37 million to 16 million in 2018.

The result, according to the Lilly School of Philanthropy at Indiana University, could be a $13.1 billion drop in annual charitable giving in 2018. 

Nonprofits that work in human services are likely to experience bigger impacts from the reduction than others, says David Thompson, a vice president at the National Council of Nonprofits.

Not-for-profit colleges and hospitals “are probably going to be fine because they tend to have development offices and tend to have big donors,” he says. “It’s the front-line human services groups. They rely on donations in the community and those are the ones that are probably going to dry up.”

Some GOP leaders dispute the predicted drop in giving because they believe the tax cuts will create jobs, put more money in people's pockets and allow people to support nonprofits more, not less.

"At the end of the day, track the last half century, track charitable giving, there’s one thing that drives it -- a stronger economy," said House Ways and Means Commitee Chairman Kevin Brady at an event in November. “When the economy is pumping, charitable giving dramatically increases. When it goes down, we see the exact same effect as well." 

Some research, however, debunks that argument.

"Back in the 1970s, when the top rate of federal income tax was 70%, wealthier Americans (people with incomes of over $500,000 in 2007 dollars) gave around twice as much of their money to charity than they did in 2007, when the top rate had fallen to 35%," reports The Wall Street Journal.

In light of the new law, Thompson hopes state legislatures consider enacting policies that encourage charitable giving. Michigan, for example, used to offer tax credits for donating to food banks, homeless shelters and certain other nonprofits. The state eliminated those credits in 2011, but the tax deal in Congress may create an opportunity to revisit them.

Last week, Michigan Gov. Rick Snyder announced that he wants to avoid the higher personal income taxes that would otherwise hit residents as a result of the tax deal. If the legislature is looking at ways to provide some financial relief to residents, Thompson says, “why don’t you put back those tax credits?”

State advocacy is going to be critical this year, says Marlo Nash, a vice president at the Alliance for Strong Families and Communities, a national organization that represents private nonprofits in the human services sector. While nonprofits would love to see new state tax incentives to promote charitable giving, they’re also trying to avoid state actions that -- despite being well-meaning -- could inadvertently compound the negative impacts of Congress’ tax deal.

For instance, California Senate leader Kevin de León introduced legislation in January that would let residents donate to a newly created state fund and deduct the amount from federal taxes. The proposal does not specifiy how the state would use money in the fund but notes that 17 states use a similar model to provide financial support to private education. Some towns in New Jersey are exploring a similar scheme. (The proposals are a workaround for a new provision that reduces how much people can deduct in federal taxes for paying state and local taxes.)

Some nonprofits, however, worry that those new government funds would become new competition for donations.

“You might be directing funds away from charitable organizations in the state,” says Jamie Tucker, a director at Independent Sector, a national coalition of individuals, nonprofits and corporations engaged in charity.

This year, Independent Sector is pushing Congress to consider a universal charitable tax deduction, which would allow people to itemize deductions for donations beyond what they take in the standard deduction. Republican lawmakers in the House and Senate sponsored bills last fall that would have created a universal deduction, but it didn’t end up in the final tax deal.

“We had a very short window, but we did have a lot of support for the concept,” Tucker says. “We do believe we will be able to show reductions in giving over time to help make that case.”

Nonprofits will also have to adjust their fundraising strategy and messaging for donors. Thompson says they will likely try to build closer relationships with wealthier donors who are still better off itemizing large charitable gifts than taking the standard deduction. And instead of playing up the tax breaks, they may focus more on the social return on investment.

Even before the tax deal, some nonprofits sought to increase engagement among small donors, particularly millennials, who give to make an impact.

"For most people, the tax policy is rarely the main reason they give," says Steve Taylor, a senior vice president at United Way Worldwide. "Charities have to show their value to donors far beyond the tax incentive." 

But the tax changes certainly make fundraisers' jobs more challenging, says Lee Sherman, president and CEO at the National Human Services Assembly, a national organization representing nonprofits: “When we think about it on the broad scale, across the nation, even taking down a few percentage points of the total giving is a lot of money."