While there is no shortage of charitable causes, there is a shortage of money to fund all of the groups doing good work. This simple truth has some wondering how to increase the amount of money available to civil society.
For example, Congressman Kevin Brady (R-Texas) chairs the House tax-writing committee and has said one goal of tax reform is to “unlock more charitable giving in America.”
One way to do that would be to allow all Americans to deduct their charitable contributions, including taxpayers who do not itemize. This is an idea that many in civil society have gotten behind, and there are other ideas out there too, such as eliminating the cap on how much can be deducted from income (currently only 50 percent of adjusted gross income can be deducted) that are worth considering.
One idea that should not be considered, but is sometimes proposed, is requiring foundations to increase their annual payout rate from the current five percent.
A recent opinion piece at Fortune.com even called for the payout to be raised to ten percent, ostensibly to make more money available to the victims of recent hurricanes. While well-meaning, this and similar proposals would have a long-term negative effect on civil society and future community needs.
It would also effectively be a backdoor way to end the ability of foundations to operate in perpetuity.
At the Philanthropy Roundtable we generally encourage philanthropists to consider spending down charitable assets rather than establishing a perpetual foundation, but we also think it should be up to the person establishing the foundation to decide.
The math is fairly straightforward – according to a recent Council on Foundations report, the ten-year average for foundation investment returns is under five percent. A ten percent payout combined with five percent returns means that every year, foundations shrink in size and give out less money than the year before. Over time, foundations would be depleted and close their doors.
Forcing foundations into terminal decline would deprive many communities of the funds that enrich local civic life and even serve as an emergency backstop.
For example, the Houston Endowment was founded in 1937 and has grown from an original gift of $1 million in its early years to about $1.7 billion today, allowing it to provide an average of $71 million in grants to Houston-area nonprofits each year.
In the wake of Harvey, the Houston Endowment has been able to address urgent-short term needs that wouldn’t have been covered by other funding sources. Had a ten percent payout been required over the Endowment’s lifetime, payouts would have outpaced the foundation’s interest earnings. As a result, the Houston Endowment might have been spent down long ago and wouldn’t have been around to meet the needs of the community following Harvey.
Moreover, the perpetual nature of foundations like the Houston Endowment – made possible by the current five percent requirement – not only ensures that they are still around when disaster strikes, it also allows them to take the long view and make and sustain investments that may not be realized for years to come to prevent future crises.
Other Texas-based foundations are already planning for the long-term recovery from Hurricane Harvey. Long after the television cameras are gone, the flow of federal funds has ceased, and individuals giving to charities experience donor fatigue or have their attention drawn elsewhere, these foundations will remain to fund those parts of the recovery that last for years or even decades.
Similar stories abound nationwide of local foundations serving as vital resources for communities in times of crisis. For example, the Charles Stewart Mott Foundation in Flint, Michigan has pledged up to $100 million over five years to help meet the needs of residents exposed to high levels of lead in that city’s drinking water.
Perpetual foundations also are the mainstays of many charities, providing steady support year after year for local community needs including homeless shelters, arts programs, conservation efforts, youth sports programs, and other important pillars of civil society. Such charities might receive an initial boost with an increased payout requirement, but it could not be sustained and over time funding would dwindle and eventually disappear.
It should be up to each donor to decide whether to concentrate his giving over a short time period or establish enduring assets that can meet community needs well into the future. Forcing foundations to spend themselves out of existence by increasing the payout rate is a short-sighted way to boost charitable giving, and those wanting to increase the resources available to civil society should look elsewhere.
Sean Parnell is vice president for public policy at The Philanthropy Roundtable.
2 thoughts on “Higher Foundation Payout Requirement Would Be A Mistake”
There’s a lot here, much of it beyond the focus of the original article, so I’ll just say on those matters that there’s nothing wrong with encouraging philanthropists to collaborate more, to consider more long-term investments, and to look in particular at communities that have been historically marginalized. But there’s no necessary link to payout rate – in fact, discussions on these topics are active and widespread throughout the philanthropic community, even with the current 5 percent payout requirement.
Two other quick notes that go to the point of the article:
1. Most foundations do not raise money (there are exceptions, most notably community foundations and operating foundations), so I’m not sure there’s much reason to believe grantmaking foundations are concerned about outreach as a way to bring in more revenue.
2. Foundations probably could get higher returns from their investments, but they would almost certainly have to accept greater volatility. Generally speaking, foundations tend to invest more heavily in lower-risk bonds rather than higher-risk stocks. This does mean a lower return in most years, but it also means that a down year in the stock market doesn’t force foundations to cut their grantmaking substantially (and to the extent that the market tracks at least somewhat the economy, when there’s a down year in the market – think of the 2007-2009 bear market when the S&P 500 lost about half its value – is exactly when you want foundations to be able to, at a minimum, maintain their giving).
Hope this helps to clarify the matter, good luck with your studies! Feel free to reach out to me at my work e-mail if you have further questions.
Thank you for writing this article, it definitely gives me more perspective as I’m studying social policy at Columbia University and gaining a stronger understanding of the various roles that government, non-profits, and philanthropy have in addressing social issues.
I wonder, however, if the 5% annual return for philanthropies depends largely on numerous factors such as geographic location, total assets, engagement with community, notoriety/marketing, etc. Assuming a 5% interest rate annually, without increasing efforts in marketing, outreach, partnering with other philanthropies, engagement with the community (to name a few) sounds somewhat suspect.
I am more inclined to believe that philanthropies, which operate strategically, are also aware of their public image. Therefore, in order to increase revenue/donations, there must be an outreach arm. Unless the outreach is done poorly, or complacently, that 5% rate should be increasing.
That being said, if the priorities for development are strong, then payout rate of the philanthropy can also increase proportionally.
On the other hand, there is a large case to be made for the increased payout rates due to the well-researched returns of investing in empowerment programs. Here’s one: http://anysyb.net/YB_PolicyPaper_2010_v2.pdf
While the resource can speak for itself, there’s also something to be said around the reason philanthropies exist. If philanthropies are helping in various sectors, is there not a level of comfort for policy analysts and government officials to shoulder less responsibility? If government cannot fully provide for our citizens’ needs, and relies heavily on a sector that is in “terminal decline”, would this not provide greater incentive to reform policy? My thinking is that a dying philanthropic sector would signal that 1) philanthropies are really trying to help urgent issues, while preventing the festering of larger ones down the road and 2) even with these efforts, more needs to be done, illuminating a long-standing gap which 3) may lead to the formation of new entities, startups, etc to seek to fill these gaps.
While the filling of the gaps is one issue, another is of collaboration. This is often the case in philanthropy/non-profit/public partnerships; it is unclear who is doing what work. There is often double-dipping, and therefore, double spending. If we can create better partnerships, cultivate alliances or build coalitions, then we can spend our money more strategically to address social issues which disproportionately affect marginalized communities.
1) Philanthropies could probably make more than 5% return if they wanted to
2) Increasing payout rates signals the intent and specificity of philanthropic efforts, which can improve relationships with more radical non-profits, who are typically on the margins of funding from all sources to begin with (something about wariness due to the non-profit industrial complex)
3) If increasing payout still doesn’t resolve issues, this can spark policy reform to address gaps, or other types of ventures (it screams “things STILL aren’t working!!”) – yes, this is a risk. But whose risk is more important? The philanthropy taking a chance, or the youth & other marginalized communities who still aren’t adequately supported in making ends meet, pursuing education, healthcare, affordable housing, etc? Who are we valuing more by maintaining this payout? A long-term agenda for a philanthropy maintains the social issues which fester and become more expensive over time; perpetuity is complicit in maintaining a long-term problem.
4) None of these efforts, regardless of payout rate, will be effective without strategic coalitions and alliances – this needs to happen NOW more than ever, and is of increasing importance as more non-profits spring up