The Magazine

No Tax-Free Lunch

Charities and the tax code.

Sep 1, 2003, Vol. 8, No. 48 • By CHESTER E. FINN JR.
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THE SALMON-AND-RASPBERRIES world of private foundations is rattling its Pellegrino bottles over a tax bill that would alter a 30-year-old practice whereby most of the foundations' operating expenses--lunch included--are classified as "charitable activity."

A bipartisan cast in the House of Representatives, led by majority whip Roy Blunt of Missouri and Democrat Harold Ford Jr. of Tennessee, reportedly backed by the Bush administration, wants to bar foundations from counting "administrative expenses" toward their annual "payout" threshold. Please don't yawn. The terminology may be arcane, but the implications are sweeping and not necessarily welcome.

The mandatory payout rule for private foundations dates to 1969 when Congress--alarmed by donors who deducted large gifts to foundations that devoted little of the money to bona fide philanthropic activity--imposed a minimum annual spending rate on these nonprofits. At first, it was 6 percent of a foundation's assets, eased in 1976 to 5 percent.

Under current IRS regulations, almost everything foundations do with their money can count toward the obligatory charitable payout. This includes all overhead costs--which is what raised the eyebrows of Rep. Blunt and his cosponsors. It's no secret that some foundations live high on the hog, with big salaries for staff, generous stipends for trustees, and fancy offices--check out the Ford Foundation's soaring arboretum-atrium on East 43rd Street--not to mention comfy retreats in scenic places. Some also have sprawling public-relations staffs and innumerable consultants. In the name of philanthropy, foundations spend a lot of money on themselves and the upper-middle-class professionals they employ.

The bill's supporters hope that barring foundations from counting their overhead costs and various self-indulgences as charitable activity will ensure more of their money reaches the needy people they are supposed to help. For this reason, the new bill has been hailed by many charities that dream of gaining billions in additional grant dollars if it becomes law. (Let us not speak of the high-living and fat overheads that also characterize some of the 501[c]3 outfits on the receiving end.) Much editorial applause has followed. "Wealthy charities are most generous to themselves," scolded USA Today. "Bill promises billions to charities," shrieked a headline in the San Jose Mercury News.

The conservative opinion world has also supported the bill, drooling over the chance to stick it to Ford, MacArthur, and other major funders of the left wing. National Review and the Wall Street Journal have editorialized in favor. Most prominent right-of-center foundations welcome the measure or have declined to oppose it. They, too, would like to bring Ford and Carnegie and Packard down a notch. Of course the big liberal foundations are fighting back. The wealthiest of them banded together to hire former representative Bill Paxon, now an influential GOP lobbyist, to kill this feature of the bill.

But like most tax issues, this turns out to be more than a simple dispute between white-hat congressional crusaders and pampered moneyed interests. There is the awkward fact that America's 60,000-plus private foundations are so varied that these well-intended reforms cannot be uniformly implemented without crippling a lot of genuine charitable activity. Blunt's bill turns out to be, well, too blunt an instrument.

That's because its drafters assumed that all foundation expenditures split neatly into two categories: grants and overhead. Not so. Many of these organizations also engage in direct services that advance their charitable missions, but don't take the form of grant-making.

The Oklahoma-based Samuel Roberts Noble Foundation is such a hybrid. Besides making grants to (mostly conservative) charities, it has a sizable in-house scientific staff engaged in agricultural research. It devotes more than half its assets to such direct charitable activities. The Baltimore-based Annie E. Casey Foundation, besides making grants to (mostly liberal) causes, has an arm (Casey Family Services) that directly aids hundreds of needy kids and families, mainly in New England, with foster care, adoption, counseling, and such.

The far smaller Thomas B. Fordham Foundation, where I work, spends about two-fifths of its budget on direct education research (evaluating state academic standards and tests, for example), communication (an e-newsletter about school reform), publishing (our staff edits--and sometimes writes--the reports that we commission), and technical assistance, particularly to charter schools in Dayton, Ohio. Some of this we handle by making smallish grants to other organizations, but much is done via contracts (to expert researchers, for example) or by deploying our own tiny staff to work directly with schools, other education reformers, and policymakers. All of it conforms to our mission, which is to reinvigorate primary and secondary education, nationally and in Dayton, pursuant to academic rigor and school choice. Yet much of it wouldn't count as charitable activity under the new bill.

Hundreds of such hybrids inhabit the foundation world. How will they respond to the Blunt change? Some might spend more from principal, gradually shrink their endowments, and go out of business. (Although conservatives dream otherwise, the Rockefeller Foundation will certainly survive with the help of clever accountants and lawyers, while real pain awaits the family foundation with a staff of only one or two.) Others will shift from direct services to grant-making, though that won't necessarily make for a better world. (A troubled charter school, for example, may need expert advice as much as it needs cash.) Some will evade the payout requirement by transforming themselves into "operating" foundations, public charities, or other entities that are allowed to spend money pretty much as they see fit. Some could split into multiple organizations, giving much business to attorneys and accountants. It's possible that the net effect of all these changes will be a charitable wash, with little added money flowing to bona fide grantees and with those dollars even less well-monitored and evaluated than today.

In the Ways and Means committee, several compromises have been tendered to let direct charitable work count toward the annual payout. And in the Senate, Texas Republican Kay Bailey Hutchison has introduced a complicated alternative of her own. But while these variants would reduce the damage, their main achievement would be to create new opportunities for cagey foundation business officers, bookkeepers, and tax lawyers to disguise their overhead expenses as charitable activity. Council on Foundations president Dorothy Ridings has reportedly said as much to House members, but her message has not gone down well. Some members are now so eager to whack Ford and its ilk--and Ridings and her team as well--that committee aides don't mind telling hybrid foundations that it's just too bad they've been caught in the crossfire.

Is there an alternative? Yes, but not one that lets politicians claim credit for ending high living on East 43rd Street or pricking the Robert Wood Johnson Foundation's balloon. The IRS has numerous enforcement tools for policing the nonprofit sector, beginning with audits. Yet it seldom wields those tools because private foundations and their 501[c]3 beneficiaries are not very rewarding places to hunt for federal revenues. Still, even the threat of random audits and other reviews of foundation activities would curb much abuse. Yes, the Blunt bill would block some fancy lunches and--maybe--the salaries of atrium gardeners from qualifying as charitable activity. But in the complex world of American philanthropy, it would also do more than a little damage to valuable work the bill's authors may have never even noticed.

Chester E. Finn Jr. is president of the Thomas B. Fordham Foundation.