Jack Salmon, "Let’s Not Tax a Constitutional Right"

Jack Salmon says some thought provoking things in a recent Philanthropy Roundtable blog post. He is responding to the proposal to tax exempt organizations on their business and investment income. Salmon argues that doing so would infringe on the constitutional right of free association.  I am definitely not buying it.  

A constitutionally protected right to associate is part of the fabric of our society. However, recent proposals, such as those outlined in a Tax Foundation report, have suggested taxing nonprofits’ net income and investment earnings.  

Recommendations like these overlook the distinct mission-driven focus and reinvestment practices of nonprofits. Imposing broad tax burdens on the nonprofit sector could disproportionately harm smaller organizations and diminish their capacity to serve communities effectively. Punishing American citizens by taxing their constitutionally protected right to freely associate is the wrong way to address government’s rampant overspending.  

Unlike for-profit businesses, nonprofits are mission-driven entities focused on benefiting the public interest or specific causes. Their primary goal is not to generate profits for shareholders but to reinvest any surplus funds into supporting the mission. This fundamental difference sets nonprofits apart from commercial enterprises and shapes their financial practices.  

As the report states, there are large, successful nonprofits that operate similar to for-profit entities. That’s how nonprofits can compete in a landscape where individual donations to charities are down. But the revenue does not flow back to shareholders’ bank accounts, as it does with for-profits.   

Nonprofits are legally obligated to serve the public good and operate exclusively for exempt purposes under Section 501(c)(3) of the Internal Revenue Code. This designation ensures revenue generated is used to sustain and expand programs that benefit society at large rather than enriching private individuals. 

. . . 

It’s clear there are some questionable nonprofits that compete with for-profit entities and may not be following the laws and regulations designed to ensure they are operating to further their missions. Perhaps there is reason to look deeper into the small minority of entities that generate over $1 billion in revenue each year, for example.  

But it’s crucial to keep in mind the Tax Foundation found 325 groups of this size – out of nearly two million groups. Those of us concerned with the overreach of a muscular central government surely cannot support a new tax on nonprofits to target 0.02% of the groups that may raise eyebrows. Rather than implementing sweeping tax changes, a more nuanced approach is needed to address specific concerns without jeopardizing the invaluable contributions of the charitable sector.  

Why, for example, would the government continue to fund these large nonprofits at staggering levels, only to turn around and take some of their funding back through a tax on all nonprofits? Such a scheme would make our current system even less efficient, and only serve to further grow the bureaucracy needed to administer a tax.  

Instead of punishing Americans by making association more expensive, some potential areas for review include:

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Salmon is essentially making a "destination of income" argument that exempt organizations should not be taxed on business or investment income because that income is dedicated to charitable use.  Destination of income supports tax exemption in the UK, where Salmon studied.  And maybe its worth debating, the whole notion of unrelated business underlying our antipathy towards exempt using feeder monies.  But I am just not buying the argument that taxing investment or business income violates the right to free association.  

darryll k. jones