Big Charities Must Help Fill City Coffers

Pennsylvania is not only the cradle of American liberty but, thanks to Benjamin Franklin’s efforts to establish some of the nation’s earliest voluntary associations in Philadelphia, the seedbed of its philanthropic tradition as well.

Now, a new chapter in that tradition is about to unfold there as a result of a measure passed by the legislature and signed into law last month by Gov. Tom Ridge. The law aims at no less than defining when an organization should legally be considered to be a charity and, therefore, entitled to such benefits as exemption from paying taxes.

The Pennsylvania law grew out of a widely watched court case involving Washington and Jefferson College and the city in which it is located, Washington, Pa. Saying that the private college operated more like a business than a charity and that it was therefore unfairly using municipal services without paying for them, city officials sought to collect taxes on nearly all the properties owned by the institution.

Just before Thanksgiving, the state’s Supreme Court, in a 2-to-1 vote, rejected the city’s plans. In doing so, the court affirmed a 1985 ruling (in a case dealing with a hospital) that set forth five criteria for classifying an organization as a charity.

To be so categorized, the court held that a group must: “(1) advance a charitable purpose; (2) donate or render gratuitously a substantial portion of its services; (3) benefit a substantial and indefinite class of persons who are legitimate subjects of charity; (4) relieve the government of some of its burden; and (5) operate entirely free from private profit motive.” The new law enacted by the Pennsylvania legislature contains essentially the same set of requirements.

Despite the diligence of the court and state legislators, however, only the final criterion would seem to distinguish, for instance, a private non-profit university from the rapidly growing number of for-profit proprietary or trade schools. In practice, however, making that distinction in the modern era is far more difficult than it might seem.

Until recently, groups that undertook educational, health, religious, and similar sorts of activities were generally considered to be charitable and entitled to exemption from taxation and other public benefits. But in the past few decades, large numbers of for-profit businesses have successfully begun operating in those areas, and many non-profit organizations have added commercial activities as a way of raising money.

What’s more, many non-profit organizations have become increasingly reliant on fees for their services — and, not infrequently, quite large ones at that. Washington and Jefferson, for instance, charges each of its students about $20,000 in tuition, fees, room, and board.

As the Pennsylvania court noted, that does not cover the full cost of a Washington and Jefferson education. The rest comes from various forms of financial aid, supposedly demonstrating the college’s willingness to donate a portion of its services.

But even at for-profit universities, students rarely pay for their degrees entirely out of pocket. Instead, like their counterparts in traditional higher education, they are given vast amounts of help by their colleges, usually in the form of federal scholarships and loans. And if, after making use of all the available assistance, some students are still unable to pay their bills, neither non-profit nor for-profit institutions are likely to be so charitable as to allow them to continue their studies.

Still, the fact that one set of organizations seeks to make a profit while the other does not is, presumably, a critical distinction. However, in practice, it often turns out not to be.

In a business, surplus revenues are normally reinvested to improve operations or distributed to employees, managers, and shareholders. Charities do the same, except that in place of investors, they may repay bondholders or other lenders whose capital they have drawn upon.

Many businesses see only red ink on their books. Many charities are so successful that they not only consistently realize a healthy surplus but also handsomely reward those employees who have made it possible.

In short, whether or not an organization produces a profit may be less significant than how the money is used. At the very least, the criticisms leveled at non-profit organizations that pay high salaries to their top executives, or invest in lavish office facilities, suggest that the public is far from convinced that the absence of a profit motive is a sufficient sign that an organization is really a charity.

Given that reality, the non-profit world might do better to acknowledge the increasingly blurry line between charities and businesses and look for ways to accommodate financially strapped municipalities, such as Philadelphia, where one-third of the assessed property is held by organizations that are tax-exempt under current rules.

The Pennsylvania law is important in that it contains provisions that reflect the interests of local governments, as well as charities. The measure prohibits non-profit groups from using their tax-exempt status to compete with small businesses and would allow cities to negotiate with large, financially secure charities for annual payments in lieu of taxes. It also gives charities with revenues over $10-million even stronger incentives to make voluntary payments to counties, cities, and school districts.

To be sure, many tax-exempt organizations already make payments to local governments in lieu of taxes. And many also make their facilities available for civic use, offer special programs for local groups, and try in other ways to contribute to their communities.

The challenges to tax exemption that have recently arisen in Colorado, Pennsylvania, Utah, and other places suggest that those efforts are not enough. If the provisions in the Pennsylvania law encouraging more non-profit groups to contribute to government coffers provide an acceptable way of resolving those controversies, they may prove to be more important than yet another effort to fashion a definition of charities that fails to recognize how much the arena in which they operate has changed since Benjamin Franklin’s day.

Leslie Lenkowsky is professor of philanthropic studies and public policy at the Indiana University Center on Philanthropy and a regular contributor to these pages. His e-mail address is llenkows@ iupui.edu.