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Big Philanthropy Stopped Being Charitable, Here’s How to Fix It

These organizations have a significant influence on public policy in America, all while stretching the law to enrich themselves.
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In the 1960s, when populist politicians tended to be white, Southern, and Democratic, two powerful members of the House of Representatives, Wright Patman and Wilbur Mills, took aim at private foundations and their “special” status in the nonprofit world.

Beginning in 1962, Patman led a series of investigations into how foundations were being used to avoid taxes, protect family economic interests, and promote narrow political agendas. In 1969, Mills, as chairman of the Ways and Means Committee, held hearings on private foundations that included an infamous performance by McGeorge Bundy, President of the Ford Foundation. The result was sweeping legislation that forced foundations to pay out a specified amount of money each year in grants, limited their ability to control for-profit businesses, and restricted their involvement in voter registration and other political activities.

In 2020, there is a need for a similar effort to regulate more carefully the activities of private foundations and other endowed entities, ranging from universities to local museums. During the past decade, the assets of these organizations have been swollen by a strong stock market and a new generation of ultra-wealthy individuals and families who have transferred billions of dollars into nonprofit endowments. While some people of wealth, like Pierre Omidyar, have chosen to do their giving through a limited liability corporation and forego tax advantages, most wealthy people do not take this route. Today, about $1.7 trillion resides in the coffers of private foundations and other endowed nonprofits.

This generosity has many admirable qualities, if applied appropriately. But the growth of these institutions has also had a dark side. Foundations now play an extraordinary role in shaping American public policy by funding other organizations that are deeply engaged in politically partisan activities, even though they may be following the legal restrictions. Because operating expenses can be counted towards a foundation’s payout requirement, there is little incentive to control salaries or other costs. As a result, many foundation executives have salaries exceeding $500,000 per year.

More generally, a huge amount of charitable money is taken out of circulation in order to support these institutions in perpetuity. Today, foundation endowments amount to around $1 trillion. Of that amount, less than 5% is distributed in any given year to other charitable groups. Very little of this money touches poor communities where violence, drugs, and dysfunctional schools prevent upward mobility or give their residents even a modest chance of joining the ranks of the employed. Despite the rhetoric of many large foundations, few provide direct support to community groups and other local organizations in the neediest communities.

Many universities, cultural institutions, and think tanks have also amassed gigantic endowments that have allowed them almost total independence from market and political pressures. This freedom could, in theory, be positive and engender creativity and new initiatives. But too often the building of endowments becomes a goal in and of itself, with little thought of how these resources can or should be used. And as we have seen in recent weeks, these endowed entities are now under considerable pressure to politicize their work at the expense of their core missions. It is laudable for Yale and Columbia to use some of their endowments to further diversify their faculties and student bodies. The elites and their institutions certainly need to confront their privilege and become more inclusive. But very little of this money will do much to help the poor communities of New Haven or New York. There is a growing gap between elite endowed organizations and the rest of the nonprofit sector in terms of resources, salaries, and capacity.

What can be done to restore balance within the nonprofit world and ensure that charitable money is actually used to address real societal needs? Here are some thoughts on what to do about foundations, endowed institutions, and the nonprofit sector overall.

For existing private foundations, five reforms would help address the sector’s most pressing problems:

  • 10 percent payout of net assets: Right now, to retain their tax-exemption, private foundations have to spend at least 5 percent of their net assets per year on grants or eligible administrative expenses. The most important reform would be to impose a much higher payout requirement on these foundations and force them to distribute more money each year to the rest of the nonprofit sector.
  • Operating expenses cannot count as part of the payout: If foundations want to have large staffs, fancy buildings, and multiple foreign offices, that is their choice. But that choice should not reduce the amount of money that goes to charitable organizations.
  • Prohibit compensation for foundation board members: While most foundations do not directly compensate their board members, some still do and at a handsome rate. This step would simply bring foundations in line with the best practices of the nonprofit sector.
  • Grants cannot be used for endowments or capital projects: An increased payout requirement could incentivize foundations to simply endow friendly organizations that share their outlook on the world. Thus, it is important to prohibit foundations from supporting endowments and capital projects. In doing so, they would be forced to actually put their money to work.
  • 4 percent excise tax: The excise tax was first imposed to finance the enforcement of the 1969 legislation on foundations. The sector has grown, become more complex, and is much more difficult to monitor and regulate. An increase in the excise tax would provide the resources for enhanced oversight.

For other nonprofit endowments, two steps might be useful:

  • 10 percent payout of net assets: Currently, endowed institutions that are not private foundations have no payout requirement. Harvard and other universities can simply amass billions for their investment funds, with no obligation to use this money. A payout requirement would force them to actually put their charitable assets to work.
  • No transfers to other organizations: As with private foundations, there would be a temptation to simply park resources at friendly, maybe even affiliated organizations in order to conserve capital and avoid spending endowed resources. That should be disallowed.

Finally, the entire nonprofit sector as a whole needs new restrictions on the ability of charitable organizations to engage in activities close to politics and to be more forthcoming about where they raise their money and how they use it:

  • Further limit the ability of nonprofits to lobby and influence public policy: Over time, smart lawyers have found more ways to enable nonprofits to lobby. It will be difficult to find the right means to constrict this ability, but it is essential to do so.
  • Regulate more closely the relationship between 501(c)(3) and 501(c)(4) organizations: Many advocacy groups now have both types of organizations, one that can take charitable contributions and the other capable of engaging very directly in political activities. Organizations need to make a choice between one or the other.
  • Complete and accurate transparency of all salaries and expenses: Similarly, there is only limited transparency through nonprofits’ Internal Revenue Service Form 990 reporting on how they spend their money. While the compensation for top executives can be discerned, other costs are often murky at best. There should be more clarity.

Since 1969, private foundations and, more generally, the nonprofit sector have grown tremendously in size and influence, especially in the sphere of public policy. While Senator Charles Grassley and others have paid periodic attention to abuses among charitable organizations, these sporadic efforts have not kept pace with the increasing ability of nonprofits to stretch the law to meet their purposes. These suggestions are just a start. One next step might be to simply prohibit the creation of new foundations and push everyone to follow Omidyar’s lead and create limited liability corporations. At a minimum, this would push wealthy families to make direct contributions to nonprofits rather than storing their assets in the vaults of foundations.

There is a lot of low-hanging fruit for a member of Congress or Senator who wants to take up the mantle of Wright Patman and Wilbur Mills. More importantly, if we continue to ignore these challenges and problems, the legitimacy of the charitable world will be increasingly questioned. George Soros, Bill Gates, and the Koch brothers have already attracted a great deal of criticism and concern for how they have deployed their massive, charitable assets. If we want to make sure that attacks do not grow louder and stronger, we need to take corrective action soon and bring the nonprofit world back to its charitable roots.

The author has four decades’ worth of executive-level experience at grantmaking foundations and foundation-supported nonprofit organizations around the country.