June 27, 2002 | Read Time: 7 minutes
Despite their enormous growth over the past 20 years, foundations are still required to distribute only 5 percent of their net assets each year — the minimal rate set by Congress in 1981. It is time for Congress to raise that figure.
In exchange for their substantial tax benefits, foundations have an obligation to share a fair burden of the costs of maintaining a vibrant nonprofit world and a healthy civil society. Unfortunately, foundations collectively have regarded the legal payout as a ceiling, not a floor.
In its obsession with maintaining the 5-percent payout rate, the Council on Foundations has failed to ask and answer the simple question, “What is so sacrosanct about 5 percent?” If the most important economic indicator in the country, the interest rate set by the Federal Reserve Bank, can be changed several times a year, why shouldn’t the payout rate be adjusted periodically to reflect changing public conditions and needs? Indeed, Congress probably should reevaluate the payout rate every five to seven years.
Under the law, foundations are allowed to include in their payout expenditures not only grants to nonprofit groups but also all salaries and other administrative costs, the rental or purchase of office space, trustee fees, and legal and accounting expenses. In recent years large foundations have spent only 3.5 percent to 4.2 percent on grant making. They need to do much better than that to meet today’s most-urgent public needs.
The National Committee for Responsive Philanthropy, supported by many members of the National Network of Grantmakers, an association of donors supporting social change, is undertaking an effort to persuade Congress to raise the payout rate to 6 percent in grants only. Such an increase would add more than $7-billion annually to the collective income of nonprofit organizations. It is the first time since the 1969 Tax Reform Act, which set a spending floor, that the payout rate has become the focus of serious public discussion among charities, foundations, researchers, and some politicians. It is an issue that the foundation world has tried to keep as its privileged domain.
Significantly, conservative grant makers have a better payout record than do big, mainstream foundations. A dozen conservative foundations cited by the National Committee for Responsive Philanthropy in a 1997 study reported that their average payout in grants in 1998 was 7.8 percent. That same year, 23 of the largest 25 mainstream foundations had an average grants payout of 3 percent, with a five-year average of only 4 percent. If the conservative institutions could distribute more, why couldn’t the mainstream ones do the same?
What makes the matter worse are recent developments that have endangered our social-welfare programs and the financial state of our charity world: serious cutbacks in many federal social programs, the recession, the loss of state revenue, massive tax cuts for the wealthiest citizens, the growing inequality of wealth and income, increases in homelessness, decreases in low-cost housing, and the growing competition for scarce funds among nonprofit groups.
For these reasons the expectations of and the demands on institutional philanthropy have grown. Whether grant makers will respond with more resources will be a serious test of foundations’ relevancy.
Surely foundations can do much more. The growth in their assets has been phenomenal, far outpacing the increase in grants they have distributed to charities. Although their assets ballooned to $448-billion in 1999, or 9.4 times their value in 1981, grants as a percentage of assets declined from 7.9 percent in 1981 to 5.1 percent in 1998. The projected assets for 2000 climbed to almost $500-billion, according to the Foundation Center. Although the recent recession has reduced foundations’ assets, the anticipated recovery will once again swell the coffers of the foundation world.
What’s more, we can expect an enormous intergenerational transfer of trillions of dollars to charities and foundations during the next 30 years. Foundations will have more money than charities and grant makers dreamed possible. So why are foundations so worried about a possible increase in the payout rate?
The Council on Foundations, supported by many of its largest members, including the Carnegie Corporation of New York and the Ford and Charles Stewart Mott Foundations, claims that a payout larger than 5 percent will inexorably lead to the depletion of foundation assets and the extinction of many foundations. Such a development, it contends, would violate many donors’ wishes that their institutions should exist in perpetuity.
To justify its position, the council cites a study of Michigan foundations commissioned by the Michigan Council on Foundations and conducted by Cambridge Associates, a consulting firm, that concludes that the current payout rate is necessary for the long-term preservation of foundation assets. It also refers to its own commissioned series of three studies by the consulting firm of DeMarche Associates.
Ironically, DeMarche’s last study, a report that was issued in 1999, found that foundations could have maintained their portfolio purchasing power over the past 49 years with a payout of 6.5 percent, although DeMarche qualified that conclusion by stating that the high returns of the past 15 years may have distorted its findings.
Those studies are contradicted by other research efforts that assert that foundations could maintain their principal over time with a much larger payout rate. Perry Mehrling, of Barnard College, for example, in a study commissioned by the National Network of Grantmakers, says that foundations could keep the value of their assets over the long term with a payout of 8 percent.
In the January 2002 McKinsey Quarterly Newsletter, two McKinsey analysts, Paul Jansen and David Katz, wrote that the current foundation payout rate isn’t distributing sufficient funds to equal the value of their tax benefits. They suggested that foundations distribute at least 7 percent of their net assets. And they have been joined by a growing chorus of individuals, including the philanthropists George Soros and Ted Turner, the former senator Bill Bradley, the investor Claude Rosenberg, and the mutual-fund executive Amy Domini, as well as a number of foundation executives who believe the payout rate should be increased.
The Council on Foundations’ perpetuity argument falls flat because it is based on the premise that foundation assets must be in a state of continual expansion. If the “XYZ” foundation today has $10-billion in assets and only $15-billion 50 years from now, the foundation will still exist even if its inflation-adjusted value has gone down. No donors were ever guaranteed that their foundations would grow exponentially, just as they were never assured that their stock-market returns would always increase. No major foundation will have to go out of business involuntarily in the long run with a little higher payout.
Some members of the council seem so worried by the prospect of an increase in the payout rate that they have begun a whispering campaign of their own, one that accuses advocates of a payout increase of supporting conservatives who allegedly want major mainstream foundations to spend themselves out of existence. This is nonsense.
More cynically, it implies that conservatives can’t have a good idea, regardless of motive, and that progressives and others should never agree with conservatives. “Guilt by association” is never a persuasive argument.
For too long, a small, elite group of wealthy donors and foundations has influenced the payout rate behind the scenes by quietly lobbying congressional committees without any public debate. The National Committee for Responsive Philanthropy and the National Network of Grantmakers are trying to broaden the discussion and to press for a long-overdue rate increase.
While a number of charities may be afraid to offend some of their foundation backers, it is nevertheless in the interest of all nonprofit groups to support an increase in the payout rate to 6 percent, and require that all of that be distributed in the form of grants. That rate should extend to community foundations and all donor-advised funds, which currently have no payout requirement.
The failure to support this effort would be a lost opportunity, not only to obtain substantially more money for the nonprofit world but also to require foundations to become more responsible partners in supporting civil society.
Pablo Eisenberg is senior fellow at the Georgetown University Public Policy Institute and a member of the executive committee of the National Committee for Responsive Philanthropy. He is a regular contributor to these pages. His e-mail address is pseisenberg@erols.com.
