Pressing Foundations to Give More

Controversial proposal could produce millions for charity

A controversial legislative proposal to increase charitable contributions from foundations could have

generated more than $370-million for charity in 2001 from the 25 wealthiest foundations alone, according to a Chronicle analysis.

But while the proposal in Congress is a possible boon for cash-strapped charities, it has roiled the foundation world. Many foundations argue the bill would force them to fire employees and reduce grants to small charities, and would ultimately hurt charitable causes rather than helping them. A small number of foundations disagree, arguing that the bill would produce much-needed charitable dollars during an economic downturn.

U.S. Representatives Roy Blunt, a Republican from Missouri, and Harold Ford Jr., a Democrat from Tennessee, introduced the proposal this month as part of the Charitable Giving Act, or HR 7. The bill is aimed at increasing charitable giving through a number of changes in the federal tax code.

While the bill has bipartisan support, Rep. Robert T. Matsui, from California, told The Chronicle that he and other Democrats will try to remove the foundation-payout proposal from the Charitable Giving Act. Mr. Matsui, the senior Democrat on the House of Representatives’ Ways and Means Committee, which oversees tax legislation, said foundations shouldn’t have to increase their distribution because of the investment losses they have experienced in recent years.

Salaries and Other Operating Expenses

The provision on foundation spending would require grant makers to exclude salaries, rent, and other administrative expenses from the calculation of the amount the federal government requires grant makers to provide to charities each year.

Since 1981, federal law has required foundations to spend a minimum of 5 percent of their net investment assets annually. Under current rules, foundations can include operating costs to meet that standard. If foundations were no longer allowed to count such administrative spending within the payout requirement, the likely result would be that more money would go to grants.

Mr. Blunt, the House majority whip, said he included the plan in his bill, in part, to help charities receive more money in the flagging economy.

It remains unclear exactly how much the proposal would generate, but according to an examination of the most recent Internal Revenue Service data, the 25 largest foundations spent $615-million in 2001 on operating costs. Eight of those foundations awarded 5 percent or more in grants even after subtracting those costs, however, and would not have been affected in 2001 by the legislative proposal.

The remaining 17 spent $371-million on operating costs that the bill would require to go to charity instead. If the proposal were applied to these foundations’ grant making for the years 1999-2001, a potential $1.2-billion more could have gone to charitable causes.

Research by the National Committee for Responsive Philanthropy, which advocates an increase in foundation distributions, shows a similar rise in giving if the proposal were to become law. The Washington group said that if foundations give away a full 5 percent of assets annually in the form of grants, the 100 largest foundations would distribute almost $900-million more each year.

‘Wall Against Excess’

Besides generating more charitable dollars, Mr. Blunt said he also wanted the proposal to “build another wall against excess administrative expenses.” Other members of Congress disagree with the need for an added barrier. “This case that foundations have huge salaries and overhead is overstated,” said Mr. Matsui, the California Democrat.

Foundation administrative expenses have undergone scrutiny recently in part because of a San Jose, Calif., Mercury News report that the James Irvine Foundation had paid its former top executive $717,000 in compensation in 2000 while its assets shrank by $400-million because of investment declines.

Under IRS rules, the only requirement for administrative costs is that the expenses be “reasonable and necessary,” said Marc Owens, a lawyer in Washington and the former head of the IRS Exempt Organizations division. “There’s no requirement that the expenses be the least cost possible to accomplish the organization’s objective,” he added. “It’s the same standard that applies to business expenses in a corporation.”

If Congress wants to prevent grant makers from spending excessive amounts on administrative costs, it could do so much more easily by providing more funds to the IRS to investigate questionable foundation spending, said John A. Edie, former general counsel for the Council on Foundations. Congress should “call IRS and ask why aren’t they enforcing the law,” he said. Instead, he said, Congress’s “solution to excessive salaries is to write another law that no one will support.”

9-Percent Average

The Chronicle analysis shows that, for the 25 largest funds, administrative costs averaged 9 percent of payout distributions. That percentage is slightly higher than a 1999 Treasury Department report that estimated the average to be about 8 percent for all 50,000 U.S. foundations.

The Harry and Jeanette Weinberg Foundation had the lowest administrative-cost percentage, at 0.5 percent.

For the three wealthiest foundations in the country, administrative costs as percentage of payout varied in 2001. The Bill & Melinda Gates Foundation, the largest grant maker, paid 4.4 percent in such costs, while the Lilly Endowment, the second largest, paid 2.3 percent.

The third-wealthiest foundation, the Ford Foundation, paid 10.5 percent in administrative costs two years ago. However, the foundation spent, in grants alone, 6.5 percent of its assets in 2001, meaning that after subtracting administrative expenses from its total distributions, the grant maker still distributed more than the legally required 5 percent. One reason: Ford made the largest gift in its history in 2001 — $275.5-million — to start a fund to support graduate-level education.

Other foundations among the top 25 with administrative costs above the 9-percent average ar-gue that the costs are a necessary part of their philanthropic efforts and that they are not paying for excessive salaries or luxurious offices.

Of the largest foundations, the Ewing Marion Kauffman Foundation spent the highest percentage of its payout total on administrative costs: 24.4 percent, or $28.9-million to administer $118.4-million in grants in 2001.

The foundation’s president, Carl Schramm, said Kauffman topped the list because it operates many of its own programs, such as a mentor program to help Kansas City children attend college. “We’re a hybrid grant-making and operating foundation,” he said.

Mr. Schramm worries about the proposal’s possible effect on his foundation. “Congress is raising some very legitimate questions,” he said, “but what are they going to do about the foundations that are in between being operating foundations and grant-making foundations?”

Contracts for Advertising

The Robert Wood Johnson Foundation had the second-highest percentage spent on operating costs in 2001, spending $91.4-million to provide $389.6-million in grants.

But about half of its administrative budget pays for business contracts with companies and nonprofit groups, said David J. Morse, the organization’s spokesman.

These contracts, though technically an administrative expense, have a charitable purpose, he said. For example, the foundation spent almost $9-million last year in contracts for its Covering Kids Campaign, a nationwide marketing effort to promote government health-insurance programs for poor children. If the Charitable Giving Act proposal becomes law, the foundation would be forced to administer that type of program through a third-party nonprofit group so the expenditure could qualify as a charitable grant, a move the foundation would prefer not to make because it would have less oversight of the program, Mr. Morse said.

Paul Brest, president of the William and Flora Hewlett Foundation, in Menlo Park, Calif., said the Congressional proposal would end up hobbling his organization in a more fundamental manner.

It would force Hewlett to make a “Hobson’s choice” between cutting administrative costs, including laying off employees, and dipping into its endowment, which would threaten long-term survival, he said. “We’d be asked to choose between quality programs and maintaining our endowment,” he said. “It would compromise our ability to achieve a real impact.”

Given that the foundation’s articles of incorporation stipulate that the organization continue in perpetuity, Mr. Brest said, he would cut operating costs.

Mr. Edie, the former Council on Foundations official, said most foundations would make the same choice and reduce administrative costs, resulting in a decline in services useful to grant applicants, such as producing annual reports and Web sites.

What’s more, if the bill becomes law, foundations will give more money to well-established organizations, instead of providing the “staff-intensive” grants required for smaller charities, Mr. Edie said. “They’ll make fewer grants, in larger amounts to larger institutions, that don’t require due diligence,” he said. “The grantee community that would like to see foundations pay more will be very upset when they find what it will force foundations to do.”

The Association of Fundraising Professionals expressed support for the Charitable Giving Act, but is not speaking out for or against the foundation proposal. Part of the reason the group is not taking a position on the measure is that it is not sure that small charities would benefit from it, said Walter J. Sczudlo, the group’s general counsel. In addition, he said the association is staying neutral on the proposal because its membership includes foundations as well as charities.

Foundations Not Unanimous

Not every foundation official disagrees with the bill. Diane V. Feeney, president of the French-American Charitable Trust, in San Francisco, said she supports the Charitable Giving Act because philanthropies have largely ignored the growing need for them to spend more. “Since foundations have not been willing to look at this issue, it’s going to be forced on us,” she said. “If that’s the only way to do it, I support that.” Ms. Feeney said her $40-million fund spends about 7 percent of its assets annually on grants alone.

Ms. Feeney said she also is glad the legislative proposal has sparked renewed interest in the longstanding debate about what’s more important for foundations’ missions: existing in perpetuity or spending their money immediately.

Perry G. Mehrling, a professor of economics at Barnard College, in New York, who conducted a 1999 study on foundation assets and spending, said foundations should not automatically expect to keep operating forever. “It’s not clear that perpetuity is the right financial goal for a foundation, just as it’s not clear that General Motors should exist in perpetuity.”

A foundation should continue to exist only if it can demonstrate that “its charitable purpose is still relevant,” he added.

For some foundations, spending all their money quickly might be the best way to carry out their mission, said Michael Klausner, a Stanford University Law School professor who teaches nonprofit law. A foundation dedicated to conserving open space or wildlife refuges, for example, might best serve its mission by spending all it can now to buy up land that would be protected permanently, he said.

What every foundation should think about in making that decision, Mr. Klausner said, is whether its spending benefits present and future generations equally. “The ideal solution would be that the payout rate ought to be different for different foundations’ missions,” he added. But he acknowledged that enacting legislation that treated foundations differently based on their missions is not practical.

The legislation proposed by Mr. Blunt and Mr. Ford, however, is not a constructive alternative, Mr. Klausner said. “It’s purely a backdoor way of increasing the payout rate,” he added, which is likely to drive some foundations out of business over time.

Mr. Mehrling disputed that argument, however.

He said that if foundations had spent 6 percent of their assets on grants over the past 20 years instead of 5 percent, “they still would have grown their assets.” Mr. Mehrling’s study, for the National Network of Grantmakers, concluded, after taking inflation into account, that foundation assets tripled from 1981 to 1997, while grants fell from 8 percent of assets to 5 percent. His study argued that the 5-percent minimum payout rate is too low, allowing foundations to become “sterile warehouses of wealth.”

Mr. Brest of the Hewlett Foundation says he fears Congress is taking a backward approach to achieving its goals. “If Congress wants foundations not to exist in perpetuity, they ought to address that directly,” he said. “If we’re going to have that debate, let’s have that debate instead of addressing it through the backdoor.”

WHAT THE 25 WEALTHIEST PRIVATE FOUNDATIONS SPENT IN 2001