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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6 Replies to “Should We Consider Taxing Non-Profits?”

  1. Thanks for covering this. It all comes down to the ratio of endowment income to non-profit mission expenses. At some point the University endowments of a few Universities became so big that the day to day operation of the Non-profit part of the Universities is small relative to the assets and income of the endowment. So, what do they do? They build big apartment developments on campus or buy more land to expand, then build innovation centers of research, fund startups led by faculty, buy the land under faculty and staff houses to help faculty afford to live there, and build golf courses and entertainment venues. They could let in more students and spend it on the educational mission if they wanted, but increasingly Stanford and others are building big fancy shopping Malls and multifamily developments. I think the public good would be best served by taxing income used for developments for which the primary use is not education or student services.

  2. “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. ”

    The Crimson ink with which you typed this while puffing away on your pipe is not too obvious, sir.

  3. Subtle in every way.

    BTW, do you happen to know if all of the need-based scholarships given by Yale and your alma mater come out of the annual distribution of their respective endowments?

    1. I don’t literally know the answer. But I’ve served as a finance board member for a scholarship-driven private high school, so I think the following is true: School annual budget revenues are a combination of endowment income, annual-giving philanthropy, tuition, and maybe special revenue programs like summer school, etc. To the extent money is fungible, it’s not possible or even particularly ‘true’ to overly separate out ‘tuition-money’ from ‘endowment income’ from ‘annual-giving philanthropy.’ They all add to the revenue pool, even if some/most of the endowment and annual philanthropy is earmarked or restricted in some way. Like, X donor gives endowment money for scholarships for “left-handed children from Arkansas,” but still that money that gets spent that year to pay teacher and staff salaries, maintain the roofs, buy computers, and spruce up the soccer field. More money from one source offsets money elsewhere. In that sense, tuition from some students this year pays for scholarships for other students. As does annual giving. As does endowment income. I think it’s all, ultimately, thrown into the same pool. That’s not how it gets reported to donors necessarily, but donor-reporting is an ‘Advancement/Philanthropy’ function, rather than a school budgeting function. Does that address your question?

      1. Yes, it does.

        I’ve been watching the spiraling debt for DI-A athletic departments for a while now, and think the bubble is going to pop in the next decade. Right now, a lot of schools are kicking the can down the road by requiring students to pay athletic fees, which results in student loans being used to cover athletic department debt. So, long-term debt used to cover short-term debt. I don’t think this will last that much longer, because once students figure out that they are taking out 15-30 years of debt to pay the salaries of coaches right now, they’re going to rebel against the system.

        One of the larger expenses for many athletic departments is paying scholarships for athletes, especially out-of-state athletes. One option to permanently endow every scholarship, which is what Stanford is doing. Another option is to treat every athlete like a normal student, and let them get need-based scholarships like some of the Ivies utilize. It would mean taking money from the endowment instead of television revenue to pay for tuition, but it would lessen some financial pressure, and would be treating the athletes like regular students in at least one area.

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I founded Bankers Anonymous because, as a recovering banker, I believe that the gap between the financial world as I know it and the public discourse about finance is more than just a problem for a family trying to balance their checkbook, or politicians trying to score points over next year’s budget – it is a weakness of our civil society. For reals. It’s also really fun for me.

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