As President Obama gets ready to unveil his fiscal 2014 budget this week, everybody in the nonprofit world will be watching to see whether his administration will continue its fight to limit the value of charitable deductions, especially for the wealthy.
But what nonprofits should be focusing on is another tax battle with far more serious consequences. Lawmakers and others are increasingly asking whether so many charities deserve to be tax-exempt—and charities may find it even tougher to win the battle to keep their tax status intact than to preserve write-offs for donors.
The latest evidence of the change in attitudes is a survey, released last week, of city and county officials in Indiana, conducted by Indiana University’s Kirsten Grønbjerg and Kellie McGiverin-Bohan.
It found that more than half of these officials favored requiring nonprofit schools and hospitals to make payments to government or provide services to local communities in exchange for receiving tax exemptions. More than 30 percent thought churches should be obliged to do so as well.
These findings come on top of widely publicized efforts in Illinois, Massachusetts, and elsewhere to collect such payments or to impose fees on nonprofits for their use of public services like police and fire protection. At least 18 states—and some 117 local governments—have collected such payments in the past decade, according to a study by the Lincoln Institute of Land Policy.
It’s not just that lawmakers want to levy the equivalent of tax on charities, but also that they want to force nonprofits to do more for the poor and minorities as a condition of their tax exemptions. And they want to make sure nonprofits focus their money on charitable programs.
Last month, for example, Senator Charles Grassley, Republican of Iowa, hinted he might revive his efforts to get tax-exempt colleges and universities to spend more on educating students, rather than pay high salaries to administrators and accumulate large endowments.
Not surprisingly, such developments are making nonprofit leaders “fearful,” as Independent Sector’s chief executive, Diana Aviv, put it.
“They know that state elected officials are short of cash and are looking for every opportunity —and frankly, excuse—to raid pots of money to pay for other pressing needs,” she told The New York Times.
However, in trying to prevent these inroads, nonprofits are hampered by the growing lack of good reasons to keep them tax-exempt, especially as many charities act no differently than big businesses.
Back in the early 1900s, under the laws that created the federal income tax, organizations that were established “exclusively for religious, charitable, or educational purposes” and did not benefit “any private stockholder or individual” were to be relieved of the burden of paying the tax.
This was never going to be an easy standard to apply. Indeed, one of the problems the U.S. Supreme Court had with the 1894 version of the income tax was the ambiguous status of insurance companies sponsored by fraternal societies. Were they charities and, thus, exempt from taxation?
Or were they businesses providing benefits to “private individuals” and, therefore, not exempt?
But that standard is easy to apply compared with the one that has taken roots in the minds of legislators and nonprofit leaders as the primary reason for the exemption: Charities shouldn’t be subjected to taxes as long as they are involved in work that lessens the burdens of government.
Writing last month in The Weekly Standard, the influential conservative magazine, the scholar Charles Wolf Jr. even suggested taxing charities that did not render such services.
This idea won’t work very well, no matter how much appeal it may have. For example, it would be impossible to apply the idea of lessening government’s burden to religious groups, which make up the largest number of tax-exempt groups. The Constitution forbids the government from sponsoring houses of worship; therefore, churches cannot possibly be reducing the burdens of government.
The idea of lessening the burden is also flawed because it suggests that governments will get a benefit equivalent to the value they lose by not taxing charities.
But that is often not the case.
For example, people who benefit from charities do not always live where the charities themselves live.
In one important decision during the 1990s, the U.S. Supreme Court gave up on trying to justify the tax exemption of a Maine summer camp, most of whose campers came from other states, on grounds that it was helping the county in which it was located.
Instead, the Court was reduced to justifying the exemption by ruling that a tax on the camp would unconstitutionally interfere with interstate commerce.
Nonetheless, because so many policy makers believe a key reason for tax exemption is that charities lessen the burden of government, it is not the least bit surprising that hard-pressed legislators—and local assessors—might want to see nonprofits contribute more in services or payments to fulfill their part of the bargain when government finances are stretched thin.
That might send nonprofits rushing away from the “lessening the burden” argument and toward embracing the older standard that they are educational, charitable, or religious, but that too will be problematic. After all, hospitals, colleges, museums, symphonies, and other nonprofits often look more like big businesses than like charities these days.
With much of their income coming from fees and other payments for their services—rather than from charitable donations—the case for taxing these organizations differently from other businesses is hard to make.
Charities can make another more pragmatic case for tax exemptions: If they are required to pay for government services, they might have less money to spend on the services that they themselves provide.
In addition, they could lose gifts, because their donors might not want their donations to be used for paying taxes or otherwise putting their money under the decision-making control of public officials.
The strength of these arguments in the public arena ultimately depends on how we value the benefits provided by nonprofits compared with what they cost government in terms of lost tax revenue.
State and local governments lose out on at least $17-billion in property tax receipts because of the nonprofit tax exemption, according to the Congressional Research Service—so that’s a lot of money for local entities still wobbly after the recession.
Nonprofits can be expected to fight hard to make the case that they are worth the tax exemptions they have. But in the face of rising agreement about the need to tax them, as well as their increasing resemblance to organizations that are not exempt, they will be hard-pressed to succeed.