January 12, 2010
Anything Can be Tax Exempt: More on Pilots too
Students at Stanford University Center on Philanthropy and Civil Society recently completeled a study in which they concluded that the IRS will approve just about any application for tax exemption, regardless of the purpose, as long as the organization complies with the private inurement, private benefit and political activity restrictions. The study is appropriately entitled "Anything Goes" and is summarized below:
The IRS approved more than 50,000 new organizations as 501(c)(3)nonprofits in 2008. It has approved more than 50,000 organizations for every year of the past decade, leading to a massive growth in the nonprofit sector. The number of 501c3s has grown by more than 50% in just a decade. What kinds of organizations are most often approved? How strict or lax is the approval process?Stanford’s Center on Philanthropy and Civil Society (PACS) new report examines the approval of nonprofit status by the IRS. The report is based on research conducted by faculty co-director Rob Reich over the summer with two terrific students, Lacey Dorn and Stefanie Sutton.They found that the approval rate in 2008 was above 98%. And they found that some of the organizations that had been approved are truly bizarre. The report is entirely descriptive, but the findings raise some important questions, I think, about the nonprofit sector in the United States:1. Do we need 50,000 new 501c3s every year? Do we have too many nonprofits?2. Need an organization demonstrate anything beyond the so-called “non-distribution constraint” — no profits to shareholders — in order to obtain nonprofit status? Does the charitable sector not have any substantive content to it beyond not-for-profit?3. Have Americans conflated the undeniable importance of freedom of association with an entitlement to tax benefits?4. Is the IRS the best agency to issue determinations of nonprofit status?
The study bemons the fact that there is no apparent consistent thread regarding the definition of "charitable" for tax exemption purposes and lists 20 approved tax exempt organizations the center considers "bizarre" and implicitly not worthy of tax exemption. My reaction, of course, is that the students are laboring under a fundamental misunderstanding of the meaning and purpose of tax exemption. Tax exemption is certainly not a governmental stamp of approval for the particular activity; indeed, tax exemption is often conceptualized as a means of encouraging activities that most people might view as "bizzare" (though that is not the only justification offered from time to time). There is insufficient political or financial support to gain government support for what might turn out to be a good idea over time. Anti-slavery and women's sufferage were once thought to be bizzare activities. Outlawing the consumption of animals seems bizzare to some people but supporting PETA through tax exemption is still a good idea. Which, by the way, brings me back to my debate with John Columbo regarding the propriety of PILOTS.
Its hard to essentialize someone else's argument so I apologize in advance if I get this wrong. Colombo's primary assertion, as I understand it, is that nonprofits should not be exempt from contributing to the local government fisc because the benefits they provide are no more greater than could be obtained from a taxable organization. This, I think, is the crux of our difference. In fact, I am surprised because if the argument works on the local level, it necessarily works on the federal level. I think I am correct that Clombo supports tax exemption for some activities, though he would not limit exemption to those that necessarily serve the poor. Yet the argument he relies on to subject charities to local property taxation is that local governments can get the same benefit from taxable entities without the loss in tax revenue. If true, tax exemption is a wasted subsidy in any instance. The overlooked point, I think, is that nonprofits (at least theoretically) must recycle their excess revenue into a public rather than private purpose. So it is not true that local governments get the same benefit from a taxable entity. We must necessarily speak on the theoretical level, by the way, because most certainly there are nonprofits that do not devote their excess revenue to the public good the way we would hope. This is a matter of enforcement and, if CMU is not operating for the purpose of public benefit -- even beyond the fee based provision of edcuation -- it ought to lose its exemption. But CMU does not prove the case. One of the problems in this debate is that Colombo is expressing understandable populist outrage at the exhorbitant cost of attending CMU, a cost that likely precludes all but the most wealthy from attending. Agreed and maybe Colombo is moving closer to the notion that tax exemption should be limited to organizations that extend goods and services to the poor. Even if the comparison should be between the benefits provided by tax exempt and taxable entities, it is theoretically false that taxable entities provide the same benefit. Even a respectable taxable entity does not legally obligate itself to improve the community, though it may do so as an incidental or unintended consequence of its pursuit of profit. What Hansman called the "nondistribution constraint" -- and actually got famous for coining that economic mumbo jumbo -- is that very thing that makes tax exempt entities particularly beneficial, certainly more than taxable entities and thus, arguably entitled to a tax concession. Taxable entities need never lift a finger to make life better for anybody. They can sell cigarettes or pornography or soft drink or hamburgers. Theoretically, then, it is not true that any taxable entity invariably or even likely provides as much benefit to the community as a tax exempt entity. It is only true if we do not believe that the nondistribution constraint necessarily results in public benefit (which may very well be the case as a pragmatic matter, but we are dealing with the theoretical basis for tax exemption).
The discussion necessarily allows us to hone and refine our positions so I freely admit that a vacant lot is less beneficial than a lot occupied by any legal taxable entity, even one that may contribute to obesity or cancer. But occupation by a taxable entity employing the exact same number of persons as a tax exempt entity does not provide the same marginal increase in public benefit that has always justified tax exemption. The extortion that PILOTS represents is ultimately an attack on the belief that legally mandated community benefit is of value sufficient to justify tax exemption. It is an expression of political disbelief. If Colombo is correct that taxable entities provide as much public good as tax exempt entities, then we ought do away with tax exemption altogether.
Stanford's study is appropropriately relevant to Colombo's argument because it points out that just about anybody can claim they are benefitting the public. That, though, is a matter of policing. If the claim is true, tax exemption is an appropriate trade though it is hard to know if each side receives exact value for value. If it is false, exemption should be withdrawn not whittled away in a piecemeal fashion that provides cover to local politicians who have not the courage to cut costs or raise taxes. And certainly not in a way that lends credence to the idea that community benefit is of no value.
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Posted by: Mark The Accountant | Aug 17, 2010 3:01:44 PM