Tax-Exempt ‘Shells’ and Campaign-Finance Reform

The recently suspended Senate probe into the financing of political campaigns showed how tax-exempt organizations were used as cogs in the money machine that fueled the partisan political wars of 1996. Although the committee’s chairman, Fred Thompson of Tennessee, cut short the proceedings, it is clear that both major political parties used tax-exempt organizations to channel money to particular candidates, thereby circumventing federal election law.

Such practices besmirch the good name and reputation of all non-profit organizations and add to the public’s distrust of the electoral system. As those organizations seek to define their political roles in 1998 and 2000, they and our nation’s lawmakers can draw some lessons from our increased understanding of how tax-exempt status can be misused by candidates and contributors.

The most useful distinction to make in determining inappropriate involvement in the campaign-finance and political process centers not on the Internal Revenue Service’s classifications but on the degree of independence that tax-exempt organizations are able to maintain. In that regard, there are three types of organizations: players, shells, and captives.

Players are organizations that become involved in the political process to pursue the long-term purposes of educating the public and elected leaders about issues. Players finance their activities with their own funds so they can maintain their own identities and voices.

Shells, which seem to be appearing with greater frequency as parties and candidates learn how to manipulate the system, have no agenda other than electing or defeating particular candidates. They are created by candidates, by candidates’ loyal supporters, or by political parties, and have no independent identity. Shells usually live and die in one election cycle.

Captives are previously independent organizations that are treated like shells by candidates or contributors. Although captives have their own identities and agendas, they put their independent identities at the service of political candidates and allow themselves to be used as conduits for money that has been earmarked by contributors for a particular political campaign or candidate.

Despite their differences, players, captives, and shells have one important thing in common: Unlike political parties or candidates, their status as tax-exempt groups allows them to keep secret the names of their donors. Through all three types of organizations, contributors can exceed election-law contribution limits and shield their identities.

The campaign activities of players raise questions about whether they are faithfully pursuing the terms of their tax-exempt status. That is of particular concern to the I.R.S., which says it has seen an increase in the number of organizations that become more involved in politics than the tax code permits. It is also of concern to the Federal Election Commission, which seeks to enforce campaign-finance regulations.

Shells and captives, however, do not simply serve as conduits for political money; they also serve as conduits for political speech. Although those groups are presented as independent voices in the public dialogue, they are not. Voters are simply hearing the amplified voices of the candidates behind the organizations. Such speech is intended to obscure and mislead.

Whatever other issues their campaign roles raise, players are speaking in their own voices. A player’s message is clearly identified with it, and voters are free to judge the message with reference to the entire scope of the player’s past positions and activities. Thus, players help to contribute to a truly diverse political discourse.

Political roles expose tax-exempt organizations to risks, and those risks are not the same for all organizations. Loss of tax-exempt status is a serious sanction for players, since they are pursuing purposes independent of the fate of particular candidates. That is not true of shells, which are generally abandoned by their creators after an election.

Current law permits both the I.R.S. and the F.E.C. to ignore shells and captives in analyzing campaign-finance transactions and to treat contributions to those organizations as direct contributions to candidates. Both the contributors and the candidates who take part in those transactions are then subject to sanctions if the campaign-finance laws are broken.

Current law also requires that conduit organizations report to the F.E.C. the names of contributors and the candidate who benefited from the transaction. However, few shells provide that information, and the penalties for not doing so are so insignificant that they do little to spur compliance.

Unless the cost to candidates and contributors outweighs the significant benefits of shells, their activities cannot be successfully curtailed. Rather than just penalizing the organization — which in the case of short-lived shells is largely irrelevant — it is necessary to insure that the true participants in the attempt to evade the limitations and disclosure requirements of federal election law suffer at least some consequences for their actions.

Sanctions would be most effective if Congress drew a reasonable distinction between proper and improper political advocacy based on common sense and common understandings — not on the presence or absence of certain specific language, such as “vote for” or “vote against” a particular candidate.

Such a common-sense approach would enhance the ability of players to pursue their missions in their own voices and to hold victorious candidates to their campaign promises. It would also leave little role for shells and reduce the incentives for candidates and political parties to turn previously independent tax-exempt organizations into captives.

Players should focus on speaking the truth to those in power and not on speech designed to enhance the electoral prospects of particular candidates. Shells and captives have no incentive to play that role, and the candidates and contributors who control them do not wish them to.

Any campaign-finance reform should protect the legitimate role of the players and foreclose any role for captives and shells. Seeing all tax-exempt organizations become casualties of the political wars would be a significant loss to all of us.

Frances R. Hill is a professor at the University of Miami School of Law.