Should We Consider Taxing Non-Profits?

yuck_faleAre tax-advantaged charitable organizations going to face heavier tax bills in the future? More interestingly, should they?

Connecticut state legislators introduced in March targeted legislation to tax some of the $2.6 billion in investment gains that Yale University earned on its $25.6 billion endowment in 2015. 

Yale budgeted to spend $1.1 billion of its endowment funds in the past year. A for-profit organization would normally pay taxes on the unspent $1.5 billion in net income. A 20% federal capital gains tax might generate $300 million, for example, and I guess Connecticut legislators figure a bit of state tax revenue on $1.5 billion in income could go a long way in their state. As it is, Yale (like many universities) pays just a nominal $8.2 million voluntary tax to the City of New Haven, in recognition of its local real estate tax-exempt status.

Meanwhile, a US congressional committee in February sent a letter to 56 of the richest universities – an inquiring shot across their bows regarding endowments, tuition-rates, and scholarships for lower-income students.

Taxing university endowments – at the state or federal level – would be a huge shift from current tax policy. As a longtime board member and endowment manager for my private high school myself, I feel a natural protectiveness toward educational institutions and their endowments. “You can’t touch this,” as the renowned African-American poet Stanley Kirk Burrell (aka MC Hammer) once said, in an entirely different context.

Clearly, Yale and other universities have tax-protected special status for good reasons.

One of the great renewable resources of American civil society – as admired by early observer Alexis de Tocqueville and periodically updated in popular sociological studies like Bowling Alone – are non-governmental and non-profit societies, like private universities.

We support financial strength for a place like Yale because we think society as a whole benefits, not just through the cultivation of top talent and cutting-edge research, but as a pillar of our civil society. 

Is it okay, however, to question whether that tax-advantaged status should remain sacrosanct in all conditions and for all times?

We enter the realm here of competing values, where reasonable people can disagree over how to prioritize protections for not-for-profit organizations. Here’s something that affects my view a bit.

Private Foundations

An investment advisor acquaintance of mine told me not long ago that she advises her clients to set up tax-advantaged charitable foundations for families with a net worth as “small” as $5 million, a much lower number than I would have guessed.

I would have guessed $25 million as the right starting point for setting up a family foundation, given what I presume are steep administrative costs and hassles.

Her reasoning is interesting, however, and influences the way I see the special “public good” treatment for charitable foundations, even for charities as large as Yale University.

Two good reasons

The investment advisor explained to me that the adult children of wealthy parents can derive a reasonable salary for managing the family foundation, a nice perk of being born into a wealthy family, without having to break much of a sweat.

Second – and just as importantly from the family legacy perspective – adult children with control of a family foundation’s annual giving can donate substantial sums to local charities. In this way – barring bodily odor or even more socially noxious behavior – they can procure invitations to non-profit board service. That, in turn, becomes a considerable source of social capital for life.

I remarked to my acquaintance that I figured in a smallish city like San Antonio a $50,000 annual donation could secure a board seat invitation to practically anywhere, and she concurred.

Even with just a $5 million charitable foundation, a typical 5% ‘spend policy’ on a foundation will generate $250,000 in annual giving, which can generate a lot of plum board seats for the second and third generations.

Here’s where reasonable people can have different instinctual reactions. It seems to me personally that creating a tax-shelter that simultaneously employs your children and allows them to reap private social status in perpetuity could have some societal downsides. Or at least rubs up against my admittedly naïve notions of what aristocracy and democracy look like. Maybe that’s just my own aesthetic preferences for a “social good.”

But even if you don’t share my suspicion of aristocracy, at some point these little family charitable foundations might even start to violate Warren Buffett’s maxim that “One should leave enough money to your kids so they can do anything, but not enough so they can do nothing.” 

Embracing complexity

In the end maybe we don’t need to begrudge this kind of thing too much, which after all underwrites worthy charities, even as it facilitates elite networking.

But I point it out in the context of Yale’s special status because we should remind ourselves that there are social consequences to all tax policy.

We can admire and support tax-advantages for “social good” organizations, even while admitting that:

1. Specific charitable organizations are created and financially sustained for more complex reasons than their stated mission, and

2. There could be limits – at some point – to the special protected status of charitable organizations.

And we can discuss – I should hope – those limits without jumping to the extreme of seeing ‘nationalization’ or ‘an attack on civil society.’

Would I bet the Connecticut legislature will tax Yale anytime soon, or would I bet on any change in charitable foundation law that would undercut their special treatment federally? No.

Why? Remember who writes legislation? Darned rich Yalies, that’s who, curses be upon them.

My own university alma mater – which is situated like Yale except just a teensy-tiny touch better in each and every respect – could be described similarly. But in the case of my school? “You can’t touch this.”

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