Bracing for a Tough Year

Deficit, tax-cut plans, and stepped-up government scrutiny give charities plenty of cause for concern

As President Bush is sworn in for his second term this week, many nonprofit observers believe that charities and foundations could face an unusually hostile political and financial climate in Washington that could lead to significant changes in the nonprofit world.

With a federal deficit of more than $400-billion last year and pressure from financial markets to curtail spending, President Bush has promised to make cuts to all federal programs except defense and homeland security to reduce the deficit by half in the next four years. That leaves programs for the arts, community service, education, the environment, health, housing, human services, and science and technology among those that could face big spending cuts.

President Bush has also proposed a complete overhaul of the tax system, a move that many critics say will be difficult to accomplish. But if the president gains support for his plan, it could have far-reaching implications for charities. Mr. Bush has promised that any major tax change would preserve the charitable deduction. But some tax experts say that proposals circulated by administration officials, which would eliminate most deductions and many taxes in an effort to simplify the federal tax code, would cause charities to lose money even if the charitable deduction is retained.

Monitoring Nonprofit Groups

The fiscal crisis could squeeze many nonprofit organizations as they come under increasing government scrutiny. Following numerous news reports about improprieties at nonprofit groups in the past year, the Internal Revenue Service has stepped up its efforts to monitor nonprofit organizations, while members of Congress conduct a comprehensive review of potential legal abuses by charities and foundations. A House committee that oversees nonprofit groups plans to hold hearings this year, and key senators are expected to introduce a bill this year to toughen regulations governing charities.

Nonprofit leaders have responded to Congressional scrutiny with fervor. A group of more than 175 top foundation and charity officials organized by Independent Sector, which represents over 600 nonprofit groups, have met at least three times during the past three months to examine ways to improve standards for nonprofit governance and accountability. The group plans to turn over its initial ideas to lawmakers in mid-February, with the hope of persuading them to hold off on passing new regulations.

But with a paucity of charity advocates left in Congress following the Republican gains in the U.S. Senate and House of Representatives in last November’s election, many nonprofit observers fear that the suggestions from nonprofit officials might not do enough to prevent members of Congress from making sweeping changes to how charities and foundations operate.

Some nonprofit officials are hopeful that as members of Congress watch international relief organizations speed into action to deal with the catastrophe in South Asia, philanthropy’s image on Capitol Hill will improve. But others fear that the spotlight could make it even more likely that Congress will move quickly to pass new legislation.

“All eyes are on charities, as a lot of Americans are paying attention and wanting to help,” says Paul C. Light, a scholar at the Brookings Institution and a professor of public policy at New York University. “Every nonprofit executive has got to be hoping that one of the big brand-name charities doesn’t get caught doing something stupid, because it will only give lawmakers more of a reason to regulate the nonprofit world.”

Looking Ahead

Some nonprofit scholars believe that the energy and political capital that nonprofit leaders are putting into efforts to persuade Congress to drop proposals to regulate charities should be directed toward matters that are more important to the future finances of nonprofit organizations.

“People are concerned about rules changes to charities and foundations, but they’re not looking 10 years down the road to see the effects of the current budget crisis,” says Kathleen D. McCarthy, the director of the Center on Philanthropy and Civil Society at the City University of New York. “The impact of the deficit on nonprofit groups is going to be staggering.”

Many nonprofit organziations are starting to get that message. Last week, officials from more than 300 groups — including people who advocate for children’s causes and housing issues — joined a conference call organized by the Coalition on Human Needs, a Washington alliance of about 100 organizations that promotes public policies addressing the needs of low-income individuals. The call was set up to help nonprofit officials better understand the federal budget process and what is at stake for charities because of the federal deficit.

During previous periods when the country has experienced a deficit, nonprofit groups have worried about reductions in federal money but have usually escaped broad cuts. This year is different, according to many legal scholars and Congressional experts.

“We’ve got such a huge deficit that the pressure on government to do something about spending is becoming rapidly more intense,” says Scott Lilly, a former Democratic staff director of the House Appropriations Committee and now a senior fellow at the Center for American Progress, a research and educational institute in Washington. That means that just about any government program that makes grants to charities could be a target for cutting, Mr. Lilly says.

“If people who care about these programs don’t begin to advocate for them in a more effective way,” he says, “they’re going to shrink at a pretty dramatic rate.”

Budget Math

President Bush’s promise to extend tax cuts for Americans is a key reason that many political experts expect the federal budget to come under a sharp scalpel. It is unclear what specific cuts the president might propose, but the three biggest areas of government spending — defense and security, Social Security, and Medicare, which account for about $1.45-trillion, or 62 percent, of the $2.35-trillion budget — are not likely to get less money, says Robert Greenstein, executive director of the Center on Budget and Policy Priorities, a Washington research group that studies the impact of fiscal policies. In fact, he says, because of the increasing costs of rebuilding Iraq and efforts to improve homeland security, defense spending is expected to increase.

That leaves the remaining three-eighths of the budget, or some $900-billion — which includes money for Medicaid, welfare, and other government subsidies to charities and the people nonprofit groups serve — as the only areas available to cut, Mr. Greenstein says.

As Congress starts drafting its spending blueprint, Mr. Greenstein says, “cuts of whatever magnitude the Bush plan calls for become between likely and inevitable.”

Although it is unlikely that Congress and President Bush will decide to eliminate programs like Medicare that guarantee aid to every American who needs it, many people think that the government might put limits on the money it spends on some programs. Such a move could put more burden on nonprofit groups to help needy individuals who turn to them when their government assistance goes away.

State Spending

One effect of both the budget cuts and tax changes would be to reduce state and local budgets. That could affect even those charities whose programs might be spared direct federal cuts. For example, the federal government could decide to give the money for a federal child-care program such as Head Start to states in the form of a block grant, or lump sum of money, to distribute as they choose. But a state facing a tight budget might find other uses for the money, says Bruce Astrein, senior vice president for programs at the Arizona Community Foundation.

“If Head Start has to compete with other state needs, it’s very possible some of the Head Start money will go to those other needs,” Mr. Astrein says.

States and local governments with shrinking budgets might turn to charities as a source of income, state nonprofit officials say. “When pressure on local governments goes up, we see people looking at taxing nonprofits by taking away their property-tax exemption,” says Peter V. Berns, executive director of the Maryland Association of Nonprofit Organizations, in Baltimore.

Past Cuts

Should broad federal spending cuts occur, charities might not feel the effects of reductions for some time. That is because it usually takes more than a year for charities to receive the money that has been allocated by the federal government, and any reduction in support likely would not be felt for at least that long.

But because the money that nonprofit groups get from local, state, and federal governments has already been reduced in recent years, the prospect that Congress might make further cuts to charity programs worries many nonprofit officials, says Irv Katz, president of the National Human Services Assembly, a Washington coalition of human-service groups.

Some nonprofit observers, however, doubt that Congress will make radical changes to programs that help people in need.

“Congress has a lot of trouble canceling programs,” says Peter Frumkin, an associate professor of public policy at Harvard University. Money for programs might get moved around, he says, but it is unlikely that programs will disappear entirely.

Investigating Philanthropy

All of these potential changes are taking place as key members of Congress continue to investigate many questionable nonprofit activities. Sen. Charles R. Grassley, Republican of Iowa and chairman of the Senate Finance Committee, and Sen. Max S. Baucus of Montana, the committee’s top Democrat, have said they plan to create new rules governing nonprofit groups. In the past year, they have circulated a discussion paper with more than 200 ideas for changing the way nonprofit organizations operate and have held a hearing to investigate alleged nonprofit abuses.

The House Committee on Ways and Means also is considering changes to certain types of nonprofit organizations. The committee held a hearing last summer to look at whether nonprofit hospitals do enough charitable activity to deserve their tax exemptions, or whether they should be converted into for-profit entities. And Rep. Bill Thomas, Republican of California and the committee’s chairman, has said he plans to hold further hearings to discuss the tax-exempt status of other types of organizations, including colleges and universities, whose tax exemptions Mr. Thomas has also called into question.

Many Congressional concerns could find their way into legislation that is expected to be introduced within the first few months of the session, perhaps as early as late January, according to a spokeswoman for Rep. Roy Blunt, Republican of Missouri.

Last year, Mr. Blunt introduced a charity bill that passed the House of Representatives but did not reach a conference with a similar measure that passed the Senate. Both the House and Senate bills would have allowed people who do not itemize on their income-tax returns to write off some of their charitable cash gifts, and would have allowed older Americans to withdraw money from their individual retirement accounts and donate it directly to charity without being subject to income tax.

Congressional aides, nonprofit officials, and lobbyists believe that a charity bill introduced this session might combine provisions to spur charitable giving with measures that attempt to put an end to certain abuses, such as excessive compensation, nonprofit tax shelters, and self-dealing arrangements that provide financial benefit to donors, trustees, or staff members. But if legislation to persuade donors to give more money to charities costs the government money, as both the House and Senate measures did last year, such a bill would probably meet resistance, say some tax experts, lobbyists, and nonprofit observers.

Another key issue for nonprofit groups that is high on the agenda of the Republican-led Congress: making the repeal of the estate tax permanent, a move that many charities worry would eliminate a powerful incentive for wealthy donors to make bequests.

Because charitable-giving incentives probably do not matter as much to lawmakers as security, foreign policy, and the future of Social Security — several of the key issues expected to be discussed this session — some nonprofit groups fear their needs could be ignored on Capitol Hill, says Matthew W. Hamill, senior vice president for advocacy and issue analysis at the National Association of College and University Business Officers, in Washington.

“Charities do matter,” he says, “but the policy-making process is about competing priorities, and Washington is staring at some big priorities.”

Learning Lessons

Because some issues could get in the way of charity legislation, lawmakers could end up trying to advance charity measures by attaching them to other tax bills, some tax experts say. That is how Congress last year passed new rules governing car donations and gifts of intellectual property — changes that are aimed at preventing individuals and companies from taking overly generous deductions for noncash donations.

The measure to tighten rules on car donations won support largely because it helped raise revenue for the government, several lobbyists say. The bill passed despite objections from many charities that complained that a change would take away important income.

One lesson that charities could learn from losing the car-donation fight is that they need to do a more effective job of mobilizing support from the public to build a case for their work so that sources of charity income are not cut further, says Daniel O. Silverman, senior vice president at Fenton Communications, in San Francisco. Mr. Silverman provided communications advice to a coalition of groups that advocated for less-restrictive changes to the regulation of car donations than those that were passed.

“It’s not enough to present policy recommendations to Congress and just hope for the best,” Mr. Silverman says. “If charities don’t communicate what they do and get millions of constituents to communicate that to Congress, then Congress might forget how important the sector is and might not listen as closely as they should to the recommendations coming from the sector.”

Charities have often been urged to speak up for their constituents and lobby more vigorously on their behalf. That is more critical than ever, many charity leaders say.

But some charity officials complain that a series of recent federal actions have discouraged them from advocating for their causes. The IRS last year became more aggressive about monitoring nonprofit groups for their political activities. The revenue service last year began investigating the NAACP and about 60 other charities and churches because the IRS thought the groups might have spoken out improperly for or against a political candidate. If they are found to have done so, the groups could lose their tax-exempt status.

Harvard’s Mr. Frumkin believes it is unlikely that many nonprofit leaders will let fears of government reprisal prevent them from speaking up.

“I don’t know too many nonprofits that are staffed by shrinking violets who are afraid to say anything,” he says. “The idea that nonprofit leaders are going to be suddenly silenced or intimidated just doesn’t ring true to me.”