Pointing Up the Non-Profit Paradox

The power to tax, the legal saying goes, also involves the power to destroy. But the power to provide exemption from taxation may also destroy.

That, at any rate, is the lesson that non-profit leaders are drawing from a report released in late January by the Joint Committee on Taxation. Citing the “tax benefits” that non-profit organizations receive, as well as “their nature and purposes,” the committee’s staff proposed a series of new reporting requirements — and increased public access to previously private dealings with the Internal Revenue Service — that Congress will now consider.

The recommendations range from the innocuous, such as insisting that tax-exempt groups list their Web sites on the informational returns they file, to the potentially embarrassing, such as having the I.R.S. release audit results without concealing the identities of the organizations examined. Of particular concern, however, are proposed new rules aimed at shedding light on the commercial and political activities of non-profit organizations.

Many non-profit leaders have already criticized the report’s recommendations as unfair, burdensome, and likely to have a “chilling effect” on non-profit political advocacy. Groups such as Independent Sector and the Let America Speak Coalition say the rules go beyond what the I.R.S. needs to know to fulfill its monitoring responsibilities and would put many non-profit groups at a disadvantage compared with business and political groups.

The rules, on first blush, do appear to be intrusive. But their perceived need may have more to do with the changing nature of the non-profit world than with the demands of an overly inquisitive state. Consequently, non-profit leaders may have to rethink the very nature of the “non-profit sector,” its growing commercialization and political influence, and its continued dependence on government funds. And there are only the barest of signs as yet that they are prepared to do so.

The intellectual argument used by non-profit leaders to protest the recommendations reveals the philosophical paradox of their position. In an important statement released last week, Independent Sector argued that the proposed new rules appear to be premised on the notion that the granting of tax breaks turns private organizations into quasi-public ones and thus requires them to be wide open to public scrutiny. By challenging that old and widely accepted notion, Independent Sector and other charity leaders have taken a step in the right direction. But by resting their case on the “private” nature of non-profit groups, they have also exposed the widening gap between the theory and the reality of non-profit activity.

According to supporters of the “tax breaks equals public entity” position, the reason that non-profit groups are exempted from paying taxes — and that people who contribute to them are allowed to take tax deductions — is to encourage those groups to perform tasks that would otherwise have to be undertaken by government. If that is indeed the case, the public has the right and the duty to scrutinize them — and to require them to disclose information about what they do. The expansion of government funds for non-profit groups that began during the 1960’s further justified public oversight.

Yet as Independent Sector and other groups now seem to realize, there have always been problems with that logic. For example, if tax breaks were meant for organizations that relieved government of some tasks, why did religious groups — the largest segment of the non-profit world — deserve them, especially since the Constitution prohibits the federal government from “establishing” a state religion? And why did organizations such as hospitals and universities need to be subsidized, since they had customers willing to pay for their services? Not least important, if non-profit groups were merely public sheep dressed in private clothing, how much control should public-policy makers have been allowed to exercise over what those organizations did?

The principal alternative view, which frames Independent Sector’s criticism of the proposed disclosure rules, focuses more on where non-profit groups get their income than on what they do with it. According to that view’s proponents, organizations that depend heavily on donations deserve to be tax-exempt, and contributions to them deserve to be deductible, because the tax code normally treats gifts from one person to another as nontaxable income. Rather than subsidizing organizations to perform public duties, and thus justifying considerable disclosure, the tax breaks that non-profit groups receive stem from the kind of financial relationship they have with their supporters.

That argument, however, was more defensible at a time when non-profit groups depended less than they now do on income from fees, sales, and other kinds of commerce. And it needs to be stretched considerably to encompass the full range of tax breaks that non-profit groups receive, such as property-tax exemption.

What’s more, the claim that an organization is private, rather than public, is not enough to ward off government-required disclosure. As the Joint Committee report notes, the Securities and Exchange Commission requires businesses to report considerable information related to stock-market transactions. More to the point, perhaps, federal election laws compel both candidates and political groups to reveal numerous details about their income and expenditures.

In both cases, government’s interest in preventing fraud or safeguarding the integrity of the electoral process has led to extensive public scrutiny. The question is whether the activities of non-profit groups justify a similar amount of concern — sufficient to override their claim to privacy.

If the non-profit world consisted only of small, trustworthy groups that used donations and volunteers to provide services to the needy, the answer would probably be No. But such Tocquevillean simplicity has not existed for a long time, and judging by the increasingly blurry lines between businesses and non-profit organizations — and the efforts of Independent Sector and others to urge non-profit groups to take a more active role in the political process — it is not even judged to be desirable. However, as night follows day, the growing size and influence of non-profit organizations is certain to invite proposals for greater government oversight and control.

The fact that groups like Independent Sector now acknowledge such regulations as threats to the essentially private character of non-profit organizations is a positive development. But to prevent further calls for public access to its dealings, the non-profit world must rethink many issues that go to the core of its nature.

Indeed, such a rethinking is long overdue. To maintain its claim to true privacy — and thus, to immunity from the demands of an overly inquisitive state — non-profit groups will have to lessen their reliance on government funds, create sharper lines between their commercial and charitable activities, and exercise more restraint in their political advocacy. Only then will their philosophy match the reality.

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.