|The Chronicle of Philanthropy
September 4, 2008
By Suzanne Perry
Paying It Forward — and Back
Nonprofit leaders worry as Congress rethinks tax breaks for donors and other charity policies
Like many members of Congress, Rep. Xavier Becerra — a Democrat who represents a largely Latino district of Los Angeles — is worried about the federal deficit and how to find money for social programs like providing health care to millions of uninsured children.
But Mr. Becerra, a member of the Ways and Means Committee, which oversees tax issues, regularly zeroes in on a government expense that has huge implications for nonprofit groups — the charitable tax deduction.
The tax break, he says, costs the federal treasury billions of dollars — an estimated $44-billion this year — and the government needs to be sure it is getting its money's worth.
"I'm wondering how many of those charitable contributions end up helping people who are poor, helping people who have no health care," he told a House Budget Committee hearing last September.
In an interview with The Chronicle, Mr. Becerra called the charitable deduction one of "the least accountable tax breaks," complaining that it is hard to get information about who gives money to whom and how the money is spent.
Are Endowments 'Hoarding' Money?
Such talk worries nonprofit leaders, some of whom have started to see it as part of a larger pattern.
Congress in recent years has stepped up scrutiny of tax-exempt organizations that seem too rich, too extravagant, or too much like businesses to resemble "charities." Most notably, it has explored whether to require nonprofit hospitals, which often operate much like their for-profit counterparts — lofty executive compensation included — to provide a minimum level of charity care. And it has turned up the heat on universities with large endowments, like Harvard's $35-billion, asking whether they should be allowed to hoard their assets at a time of rising tuition costs.
Additional Congressional action is unlikely until the new president and new Congress take office next January, Representative Becerra says. But next year he plans to press the Ways and Means Committee to gather more information about the deduction, possibly through hearings or studies.
"With these tough economic times, we can't afford to be walking so blindly on such an important issue," he says.
Sen. Charles Grassley, the top Republican on the Senate Finance Committee, has led the charge on nonprofit issues — including the reviews of hospitals and university endowments — and he shows no sign of letting up.
"The cost of [charitable] deductions is borne by other taxpayers, the majority of whom are not able to take deductions for their contributions," Senator Grassley said in an e-mail message. "It's fair to look at what benefits charities provide in return for the preferential tax treatment they and their donors receive."
In fact, an aide says he and other Senate leaders would now like to look at the basic tax code for charities, which has not been significantly revised since 1969. It is likely the Finance Committee will hold a hearing on that issue, and on the charitable deduction, in 2009.
The changes in 1969 created separate tax regimes for private foundations which receive money from a single or small number of sources and rely on investment earnings for support, and public charities, which generally raise money from a lot of donors or from activities related to their missions.
Congressional observers say one issue up for consideration is whether such a distinction still makes sense given that the donors and family members who created major foundations like Ford, Rockefeller, and Carnegie retain little control of the organizations, while some charities operate like foundations by holding huge endowments and distributing grants.
Some states are also rethinking which organizations deserve charitable benefits. For example, in Minnesota the Supreme Court ruled last year that a day-care center did not warrant its property-tax exemption as a charity because it did not offer its services free or at substantially reduced rates.
"It's a collision between the historic notions of charity and the modern nonprofit economy," says Jon Pratt, executive director of the Minnesota Council on Nonprofits. "It doesn't look like your great-great-grandfather's charity."
Seeking Government Revenue
The emerging questions about charitable tax exemptions and deductions coincide with a political and economic climate that could give critics more ammunition.
No matter who wins November's elections, Congress will be looking for ways to rein in the country's enormous budget deficit and pay for new programs. Many states have been hit hard by the economic downturn and are looking for new revenue. Social-service charities are struggling to meet growing demand while big universities and arts groups report record gifts.
Sentiment is growing in both political parties to encourage "giving that will meet the enormous unmet human needs that are out there," says Dean Zerbe, a former top aide to Senator Grassley who is now national managing director for Alliant Group, in Washington. "It's difficult, it's going to take a real rethink to say, Can we define what is a charity?"
Diana Aviv, president of Independent Sector, an association of big charities and foundations, sees the writing on the wall. Last spring, she assembled 16 foundation and nonprofit leaders to form the Advisory Group on Defining the Charitable Sector. Its mission: to examine the roles of charities and foundations and the rationales for their tax exemptions, as well as the charitable tax deduction.
"We decided to take a deep and hard look at every aspect of nonprofit practice for the purpose of understanding whether the sector as we know it is the sector as it should be," she says.
Some studies show that the poor do indeed get short shrift when it comes to charitable giving.
The Institute for Jewish and Community Research, in San Francisco, conducted a study of more than 8,000 donations of at least $1-million each made from 2001 to 2003.
The biggest proportion — 44 percent of total dollars — went to colleges and universities, followed by health and medical institutions (16 percent) and arts and culture groups (12 percent). Groups that provide social services received only 5 percent of the pot.
"The disparity among nonprofits is so stark that it was inevitable that elected officials would start to to take a look at this," says Gary A. Tobin, the institute's president.
Some advocates for the poor welcome such scrutiny.
David R. Jones, president of the Community Service Society of New York, an antipoverty group, hopes the new Congress and president take a hard look at deductions for charitable gifts. "Shouldn't there be a different tax treatment if the gift is going to institutions that increasingly serve a narrow elite, or be a demand that institutions that receive these gifts have to make a showing that they're serving the needy?"
A survey by his group found that 58 percent of low-income New Yorkers rarely visit the city's cultural institutions, which are supported by an array of tax benefits. One fifth of them said it was because the admission price — as much as $20 in some cases — was too high.
The charitable deduction itself increases inequalities between rich and poor, argues Rob Reich, associate professor of political science at Stanford University. Taxpayers cannot write off their charitable contributions if they don't itemize — and if they do itemize, those with smaller incomes get less of a break because they are in a lower tax bracket.
"Because the same social good is ostensibly produced in both cases, the differential treatment appears unjust. If anything, lower-income earners would seem to warrant the larger subsidy and incentive," he wrote in a 2005 article for the Stanford Social Innovation Review.
Who Serves the Needy?
Tinkering with the tax code to redress inequities, however, can be fraught with complications. For example, if lawmakers tried to create a bigger deduction for contributions to organizations that serve the needy, how would they define the term?
Steve Taylor, vice president of public policy for United Way of America, in Alexandria, Va., says his organization is trying to help society at large, not just poor people — for example by cutting the school-dropout rate in half. "There are systematic problems at some schools that are leading to very high dropout rates," he says. "If the incentives are focused only on helping kids who are poor, that doesn't allow us to address the whole system."
Mr. Pratt, of the Minnesota Council on Nonprofits, recalls that before his state in 1999 became the first to offer a charitable deduction to people who do not itemize on their tax returns, the council debated whether to support a proposal that the tax break be limited to donors who support groups that devote most of their activity to helping low-income people.
It decided against it, however, fearing that donors would be confused about which groups qualified. "You don't want to make things more complex," he says.
If federal lawmakers wanted to proceed, however, they could look to Europe, where some countries offer bigger tax breaks for certain kinds of giving.
Miia Rossi, legal affairs officer at the European Foundation Centre, in Brussels, says some tax incentives favor gifts to universities, which lag behind American counterparts in private fund raising. The Czech Republic allows corporate donors to deduct more for gifts to support research, while Bulgaria gives greater tax incentives for donations to cultural groups.
She says some charities are unhappy with the distinctions and are pushing for more uniform treatment. Indeed, any attempt on this side of the ocean to develop a tiered deduction would face fierce opposition from groups that stand to lose out.
"There's a lot of policy confusion about what organizations do or do not do in the nonprofit sector to help the poor and disadvantaged," says Robert Lynch, president of Americans for the Arts, in Washington. The presence of cultural groups, for example, can help revitalize neighborhoods and provide jobs, he says.
Barry Toiv, spokesman for the Association of American Universities, a Washington group that represents big research institutions, says, "We've always left it to the individual to decide what charitable institutions they want to contribute to."
He adds: "We find it hard to believe that donors, large or small, would want the government directing their money to one charity or another."
Mr. Tobin of the Institute for Jewish and Community Research says differential tax rates for organizations with different missions, while worth exploring, would be "a policy nightmare."
He says it may be more practical for lawmakers to focus on "nonprofits that hoard their assets" — such as universities with large endowments and no requirement to spend them.
Hospitals and Universities
Some tax experts think it's more likely that Congress will go after what some call the "low-hanging fruit" — like nonprofit hospitals and universities — than make major changes in the charity tax code.
Roger Colinvaux, associate law professor at Catholic University and a former top aide to the Congressional Joint Committee on Taxation, says lawmakers could decide to put those two groups in a separate tax category, as they did with credit-counseling groups in 2006.
The credit groups must follow certain rules to earn their tax-exempt status — for example, they may not make loans to debtors and must offer debt-management plans only as part of an educational and counseling program.
"Is this just a one-off thing, really unique to abuses of credit counseling, or something that could be the beginning of a restructuring of public charities?" Mr. Colinvaux asks.
John D. Colombo, professor of law at the University of Illinois, says he believes nonprofit hospitals have become such business-likeoperations that they probably should no longer be labeled "charitable." However, he adds, stripping them of their tax exemption cannot be done in isolation.
"We can't do that without dealing with health care for people who can't afford it," he says.
Some experts say lawmakers should explore new ways to promote the public good that do not depend on charitable tax exemptions.
Theresa Pattara, tax counsel to Republicans on the Senate Finance Committee, points to Google.org, the philanthropic arm of the search-engine company, which was set up as a for-profit entity so it could invest in businesses that seek to solve social problems.
"If there are models outside of tax exemption that work, we are clearly interested in looking at that," she told a conference of tax lawyers in April.
The Council on Foundations, an association in Washington, has been pushing the federal government to recognize a new business entity called a low-profit limited liability corporation, or L3C.
Vermont recently became the first state to recognize L3Cs, which operate like for-profit businesses generating at least modest profits, but whose primary aim is to offer social benefits, such as providing jobs in an economically depressed area.
Steve Gunderson, the council's president, would like the Internal Revenue Service to rule that foundations may give money to such entities as "program-related investments" that could be counted toward meeting the federal requirement that foundations distribute at least 5 percent of their assets each year.
He has proposed this approach while working with Sen. Max Baucus, chairman of the Senate Finance Committee, a Montana Democrat who has been pressing foundations to give more money to charities in rural areas.
Mr. Gunderson is optimistic about the outcome of Congressional scrutiny of the charitable world, saying key lawmakers have signaled they want to promote more giving to help solve social problems.
"Even with Congressman Becerra and Senator Grassley, I think we have to separate their desire to use our money in the most effective way from the possible perception that they're anti-philanthropy," he says.
He also predicts that today's young people will eventually alleviate the rich-poor charitable divide. "Whereas the grandparents wanted to give to buildings that were named after them, the grandchildren are much more motivated by what we would call economic and social-justice issues," he says.
In coming months, Representative Becerra says he will be tapping nonprofit leaders to help him examine ways to ensure that the charitable tax deduction and exemption are "a productive resource."
But Rick Cohen, a former foundation watchdog who is now national correspondent for The Nonprofit Quarterly magazine, says he hopes lawmakers will not limit their inquiries just to nonprofit officials — who are predominantly white and relatively affluent.
"It's a societal issue," he says.