It is time to undertake a fundamental reform of the charitable sector. As very wealthy individuals and their foundations exert greater and greater influence on the mission and substance of nonprofits, philanthropy risks losing its special status in American life. These holders of great wealth and the nonprofit groups that work with them have made activism, conservative and liberal, the center of their missions. Their outsized importance in the nonprofit sector has distorted the governance of many organizations and has turned cultural and educational institutions into vehicles for celebrating the vanity of their biggest donor, as well as conferring privileges on their families.
This behavior threatens to undermine the broad support that Americans have given to the sector since the initiation of the charitable tax deduction in 1917. That support was based on an understanding that charitable organizations would devote their resources to the common good, not to partisan or personal ends. It was rooted in the notion that all Americans can be part of our civic life. As big wealth now dominates many aspects of the charitable sector, responsible politicians and the general public may soon come to the conclusion that major reforms are needed in order to return the charitable world to its original mission.
In the 1960s, similar behavior led to legislation that put new restrictions on foundations, nonprofit organizations, and the wealthy who support them. At the time, the Ford Foundation and several other philanthropies were accused of engaging in political activities at all levels of government. Other foundations were criticized for using their endowments as means for the wealthy to control public companies. The resulting changes in the law and regulations governing the charitable world were substantial and, for a time, successful in curbing the worst abuses.
But, with the help of smart lawyers and the tolerance of politicians on both sides of the aisle, these restrictions have been circumvented and eroded over the past five decades. Now, it is time to undertake a new round of reforms aimed at curbing the misbehavior of foundations, many large nonprofits, and the wealthy who use these institutions for purposes that stretch our general understanding of charitable missions.
A longtime tension
This challenge is not new. There has always been a tension within the nonprofit sector about the role of the very wealthy. On one hand, rich people have been applauded for their generosity in creating and expanding hospitals, museums, universities, and other nonprofit entities. On the other hand, there has been a persistent suspicion about how they might use their donations in pursuit of their personal political, business, and other interests. In the early 1900s, the creation of foundations funded by John D. Rockefeller and Andrew Carnegie generated intense Congressional interest as legislators investigated how these new institutions could be used to advance their personal political and business interests under the guise of serving the common public good.
This wariness of the ulterior motives of Big Wealth increased greatly in 1917, when the charitable tax deduction was initiated. With the initiation of a permanent income tax, a group of wealthy individuals argued that their considerable support of organizations serving the poor should be recognized through a tax benefit. While this argument proved to be persuasive, it touched off a debate on whether philanthropy should be underwritten by the tax code and especially whether the wealthiest among us should be able to use these tax breaks to fund eponymous foundations.
In founding the March of Dimes, Franklin D. Roosevelt went out of his way to ensure that this new voluntary association would be funded largely by millions of small donors. As described in Elisabeth S. Clemens’ excellent book Civic Gifts, FDR went to great lengths to keep this charity, so closely connected to his own life, above politics despite his own very partisan identity. Indeed, the March of Dimes, the Red Cross, the Salvation Army, and most major national nonprofits adhered to this philosophy of relying on small donors and staying out of political and other controversies well into the first decades of the post-war era. Yes, big donors built new college libraries and endowed cultural institutions that bore their names. But most of the sector, including universities and museums, relied on fees, small contributions, and public support to stay in business. Their governance structures may have had a disproportionate number of rich patrons, but regular people still were involved in setting the course for these institutions.
In the 1950s, a few nonprofits gained notoriety for employing individuals who had complicated pasts and for openly engaging in political activity. With Alger Hiss as its president, the Carnegie Endowment for International Peace was one prominent target for investigators seeking to uncover Soviet influence in American life. At the same time, some charitable groups started to endorse candidates for state and federal office, often at the direction of their most-significant donors. While this practice was not widespread, it did result in a federal prohibition on explicit political activity in 1954.
Previous inquiries and reform
Concerns about the role of the wealthy in the charitable sector grew considerably in the 1960s. Wright Patman, a Democratic Congressman from Texas and chairman of the House Committee on Small Business, led a series of inquiries into how the very rich were using foundations and other nonprofit organizations for nefarious purposes. His inquiries suggested that:
- The wealthy were reaping huge tax benefits by creating private foundations and then warehousing their money in these institutions with little public benefit. In some cases, Patman’s team discovered philanthropies where almost no money was being spent.
- The sons and daughters and various dissolute relatives of the very rich were regularly employed by foundations and, in other cases, the direct beneficiaries of grants from these philanthropies.
- Many foundations were significant shareholders in the publicly traded companies founded by their donors. By controlling the foundation and its investments, plutocrats were able to shield their companies from hostile takeovers and other market pressures and receive a tax break to boot.
- Some major foundations were openly engaged in partisan politics by sponsoring targeted voter-registration initiatives and funding the political operatives of politicians favored by the philanthropy’s leadership.
These and other abuses by foundations and nonprofits groups led to a call for major reforms in how the charitable sector operates. The Tax Reform Act of 1969 was the final result of this concern about how the wealthy benefit from and abuse the prerogatives of the charitable sector. After another round of hearings and investigations by the staff of Rep. Wilbur Mills, a Democrat from Arkansas and chairman of the House Ways and Means Committee, a series of far-reaching changes were made in the legal framework of the sector. The most-notable elements were:
- Private foundations were separated from other nonprofit organizations and subject to specific rules that had not previously existed.
- Foundations were required to payout at least 5% of their assets each year in charitable grants. The expenses in making these grants, like the salaries of foundation staff, counted towards the payout requirement.
- Restrictions on self-dealing that ostensibly made it more difficult for donors to use their foundations for private purposes. Salaries and other transactions had to be reported and made available to the public.
- Limitations on a foundation’s ownership of stock in a public company. With a few notable exceptions, foundation endowments had to be diversified and could not own more than a certain limited percentage of the stock in a company.
- Much-tighter restrictions on the lobbying and political activities of foundations and nonprofits were implemented, including specific limitations on voter-registration campaigns to ensure that they would be nonpartisan.
- Charitable organizations other than foundations were required to meet a public-support test as a means of demonstrating a financial base with multiple donors.
Now, 50 years later, a similar overhaul of the rules that govern the charitable sector is needed. In the intervening period, we have seen the emergence of an ever-more-powerful group of wealthy donors and well-endowed foundations that are reshaping the nonprofit world, and not always in a good way. The wealthiest 1% in the United States now own 30% of the net assets. That concentration is growing even under the duress of a pandemic and, with it, the influence of the very rich on our civic life.
Yes, Bill Gates and other new mega-donors have made positive contributions here and abroad. But the negative consequences of these philanthropic plutocrats greatly outweigh the benefits. Five specific problems are most pressing.
First, Big Philanthropy is increasingly political and increasingly involved in trying to shape the outcomes of elections. The restrictions on support of voter-registration campaigns were breached by smart legal advisers in the 1990s. Now, major foundations and wealthy individuals pour millions of dollars into efforts to register and motivate specific “underrepresented” populations that have strong partisan implications. Similarly, this same group of donors has financed a range of initiatives to alter the rules and conduct of elections. And a few ultra-wealthy, like Tom Steyer and Michael Bloomberg, have used their charitable billions to burnish their own images and purchase goodwill among the public as they pursued political office.
Second, the biggest donors have also used their financial power to steer and influence public policy in many areas of American life. Thanks to the largesse of the Gates Foundation, hundreds of school districts were encouraged to embark on risky and ultimately failed reforms that had been cooked up by well-intentioned experts with little community-level experience. The climate-change movement may have millions of supporters, but the bulk of the money that supports the biggest environmental groups comes from less than 100 wealthy donors. In foreign affairs and national security, the Koch entities, George Soros, and other fat-cat givers are pouring millions into think tanks and other institutions in hopes of radically reshaping American priorities and investments.
Third, in the 1960s, foundations were accused of simply being tax-subsidized warehouses for the wealth of their rich donors. The payout requirement was one attempt to address this problem. But the advent of alternative investments in the 1980s has allowed many foundations to grow dramatically despite having to give away 5% of their assets each year. And the ability to apply operating costs towards that 5% minimum has undoubtedly encouraged an increase in staff size and salaries at the big foundations. At the Ford Foundation, four employees made more than a million dollars in 2018 and another six made between $500,000 and a million. Not bad for charitable work.
Fourth, the domination of Big Wealth has shaped the governance of many major institutions. Not so long ago, universities, cultural institutions, and other big nonprofits were proud of having boards that reflected the key stakeholders in their organization. Today, at most of these institutions, board seats are handed out to big donors with few if any slots left for regular constituents. Does this emphasis on rewarding big contributors make a difference in how these institutions operate? We know that in most of these institutions, administrative staffs have grown considerably during the past three decades as the care and feeding of big donors has become a major priority. While it is only a correlation, salaries for the leaders of these institutions have also grown substantially as the wealthy have assumed control of these institutions. More important, new programs and new capital projects are certainly driven by the preferences of a major donors rather than by other considerations such as need or how best to fulfill an organization’s mission.
Finally, while the wealthy have always received preferential treatment from the institutions that they support, it seems certain that this tendency has increased in recent years. The college-admission scandal, where rich families found ways to buy their children spots at elite institutions, is one prominent example. The ability of Jeffrey Epstein to get the attention of Harvard and MIT officials is another case in which big money was used to buy a sort of strange philanthropic expiation of awful behavior. Whether there is a concrete payoff or simply a burnished image, the very wealthy have become increasingly adept at getting what they want from the charitable sector.
Many ideas, two objectives
What should be done? There are many ideas out there as to how to bring philanthropy back to its original purpose. There should be two objectives in reforming the sector. First, we should find ways to reduce the power of the ultra-wealthy and their abuse of our current system. But second, we should also respect the right of this elite group to use their money as they wish. How do we achieve this result?
I would propose putting a $10,000 cap on the charitable tax deduction and making it applicable to all contributions, including those to foundations and donor-advised funds. The value in adopting this approach is two-fold. First, it still allows individuals to deduct modest contributions to nonprofit organizations of their choice. In 2017, about 37 million taxpayers used the charitable deduction, for an average amount of $5,500. Much of this money goes to support churches, United Ways, and other activities that truly promote the common good and often in a very community-based manner.
Second, it would eliminate subsidization of the huge contributions that our tax system allows each year for the wealthiest among us. For the very wealthy, this tax deduction is, at best, a subsidy for storing massive amounts of money in private foundations and donor-advised funds for use in the far future. More important, it subsidizes the significant transfers of money that these individuals make to highly politicized nonprofits on both sides of political spectrum. Capping the deduction would make these donors honest and force them to treat much of their philanthropy the same as their political contributions.
While this proposal would slow the creation of new foundations and possibly send a message to the existing philanthropic world that politicized behavior will have consequences, it does not address the current behavior of organized philanthropy. Short of dismantling these massive storehouses of wealth, we should, at a minimum, raise the payout requirement for foundations from 5% to 10%. In addition, we should not allow foundations to use operating expenses as a means to fulfill the payout requirement, and we should impose restrictions on grants for endowments or capital projects so that foundations do not simply transfer their wealth to friendly organizations.
These modest proposals would have at least four positive consequences. First, the vast majority of Americans would not see any difference in their taxes due to this cap. They could continue to support their favorite charities, even those that are very politicized. And by pushing foundations and donor-advised funds to give away more money at a faster pace, one might actually see an increase in charitable giving.
Second, it would begin to discourage the very wealthy from using charitable organizations as a means for pursuing political ends. Some billionaires already use structures to pursue their political and philanthropic goals that do not qualify for a tax deduction. This cap would push others to follow this path.
Third, it would also democratize the charitable sector by forcing all institutions to take small donors seriously. Rather than take a subsidized $50 million grant from some technology billionaire, universities, museums, and other institutions would have to develop the means to convince regular Americans to make modest contributions for their work. In doing so, this democratization of philanthropy could be the most-important step towards rebuilding the legitimacy of the sector.
Fourth, the cap on charitable contributions would likely increase federal tax revenues at a time when we need to address a growing deficit. For conservatives, more money for the government is not an ideal situation. However, we will have more influence over the use of government money than we will ever have over the spending of wealthy individuals and foundations. It is not a perfect trade-off, but it is worth making.
A final reform step would be to alter the public-support test that nonprofits must pass so that they qualify as charitable organizations and donations to them are tax deductible. The test’s calculation is complicated, but at least one-third of an organization’s annual resources need to come from the public—defined as individual donors who each give less than 2% of the organization’s total budget, government agencies, and “donative public charities” like United Ways. The aim of this requirement is to ensure that charitable groups have diverse sources of support and diverse governance. In other words, it is designed to prevent one or two big donors from creating and controlling a nonprofit for whatever purpose.
A serious reform package would raise the public-support requirement to 50% and redefine eligible individual donors as those who give less than 1% of organization’s budget. While this requirement would make it more difficult to start nonprofits, it would also provide a guarantee that new groups have a broad base of financial support. It would make it more difficult for a foundation or a wealthy individual to provide a very large proportion of an organization’s budget, as well, and to exert excessive control on its mission and programs.
Comparatively modest proposals, and controversy and questions
Compared to some other proposals for reforming the nonprofit sector, this package of changes is relatively moderate. It would not eliminate private foundations, but it would force them to spend more money on charity in general and less money on staff. It would not prohibit the very wealthy from giving away their money as they see fit, but it would limit the extent to which the general public subsidizes their giving through tax deductions, and it would encourage political money to go to explicitly political uses. It would not prevent the creation of new, innovative organizations, but it would ensure that new and existing entities truly have a broad base of support.
These proposals would certainly generate controversy. From the left, activists will see them as an attempt to discourage the wealthy from political activism in the guise of charity. From the right, tax-sensitive observers will decry the fact that the limit on the charitable deduction will simply give the government more money to squander. And from both sides and the center, there would be wonderful stories about the virtues of the very wealthy and their foundations, then questions as to why anyone would want to change this wonderful system.
The fact is that much of American civil society is in good shape and should not be changed. Churches, community groups, local service agencies, and a host of other worthy ventures would not be touched by these recommendations because they do not rely on Bill Gates or Charles Koch for support and they do have dozens of small donors and volunteers who keep them alive. Most of these groups are not used as vehicles for political purposes. These organizations, not the big think tanks, universities, and cultural institutions, should be the heart of our nonprofit world. Let us hope there is reform of the charitable sector before it is too late.
The author has four decades’ worth of experience at grantmaking foundations and foundation-supported nonprofit organizations around the country.