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 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.