The Debate Over Foundation Payout Rules

To the Editor:

The furor over the provision of HR 7 that would exclude administrative expenses from the 5-percent payout calculation for private foundations has some interesting lessons, regardless of what side of the debate you are on.

Pablo Eisenberg and the folks at the National Committee for Responsive Philanthropy give voice to the concerns of many nonprofits regarding the dwindling revenue available for mission work while foundation endowments continue to grow (“Foundations Unleash Ugly Tactics to Protest House Bill,” July 24).

But Paul Brest and others have also raised convincing arguments about the possibly deleterious effect the proposed rule change will have on foundations making smaller, riskier grants, and about the effects of the proposal on the perpetuity of foundations (“Sarcasm Is No Substitute for Sound Analysis of House Bill,” August 7).

I, like many others, am somewhat conflicted about the right answer to this difficult question. The most interesting thing to me, however, has been to observe how aggressively and effectively many foundations are fighting the proposed changes.

When the direct self-interest of foundations is threatened, they take aggressive action to impact public policy, and rightly so. Too bad so few foundations provide support for nonprofit groups that also aggressively seek to impact public policy when the interests of their constituents are affected.

Why are some foundations comfortable funding a volunteer literacy program but not a community organizing campaign to pressure public-school districts to improve reading instruction? Why is there greater comfort in funding direct provision of health services for the uninsured than in funding organizations seeking to expand health coverage for the working poor?

Community organizing and advocacy to impact public policy are often the best strategies to achieve a philanthropic mission. Yet only 1.1 percent of foundation funding goes toward “social-change philanthropy,” according to a study by the scholar Craig Jenkins.

Foundations know the importance of public policy when their own self-interest is at stake. Perhaps the way to help more foundations see the importance of organizing and advocacy in relation to the philanthropic issues they care passionately about is to tie the direct self-interest of foundations to the social and economic problems of our society.

What would happen, for example, if Congress capped pay for foundation staff as a way to curb administrative expenses, instead of the current proposal in HR 7? Program officers would be limited to earning three times the federal minimum wage and senior executives five times the federal minimum wage. Can you imagine the president of a major foundation earning a maximum of $53,560 per year? Perhaps more foundations would make grants to organizations seeking to increase the minimum wage.

And what if Congress mandated that all foundation staff and trustees should have a health-insurance plan and prescription-drug coverage no better than the average American family has? I bet groups organizing for universal health care would start to see new grants.

What if the foundation-payout calculation was directly indexed to the federal unemployment rate? When we have 4-percent unemployment in the country, the payout rate is 4 percent. When unemployment rises to 8 percent, the mandatory payout also rises to 8 percent.

And what if administrative expenses were included in the payout calculation so long as the reading performance of public-school students was improving in the foundation’s service area, but were excluded if performance was stagnant or declining?

Self-interest is a powerful motivator. If we can link the self-interests of the wealthiest Americans with the self-interests of the poorest, we’ll go a long way toward solving some of our most pressing social and economic problems.

Aaron Dorfman
Executive Director
People Acting for Community Together
Miami

To the Editor:

When the gods wish to punish you, says the ancient proverb, they make your dreams come true. Nonprofit organizations may soon learn the truth of that ancient wisdom if HR 7 becomes law. Under the legislation, foundations would not be allowed to count certain administrative overhead expenses toward the federally required 5-percent payout of assets. This would seem to make nonprofits’ dreams come true, for the bill’s supporters claim that it would make available $3.2-billion in additional grants. If it does come to pass, however, the legislation will punish nonprofits in ways that will be difficult for them to anticipate.

Why? Because foundations that want to survive in perpetuity must now make an average return of 9 percent in order to remain viable. This includes the 5-percent mandatory payout, a return of 2 percent to offset inflation, and a further return of 2 percent in order to achieve real growth. Money managers will tell you that it is very difficult to achieve a sustained 9-percent rate of return. Now, if an additional 1 percent of administrative overhead must be covered, the required return will jump to an almost unattainable sustained 10 percent. Hence, foundations will be eager to cut administrative overhead in any way that they can.

On first blush, nonprofits might cheer for reduced foundation spending on overhead. Foundation overhead costs, however, pay for a lot of things that nonprofits value. For example, overhead costs pay for conducting research on new programming opportunities, for finding new organizations to support, for technical assistance to grantees, and for the evaluation of the work that grantees do. All of these things, which directly benefit nonprofits, are likely to be slashed, or eliminated altogether, by foundations intent on surviving in the face of changed payout requirements.

Many foundations will cut overhead costs simply by giving very large grants to very large, “safe” institutions, instead of making smaller grants to smaller, “riskier” nonprofits. This is good news if you run a mega-nonprofit, but it will hurt smaller, newer, and community-based nonprofits. Other foundations may choose to meet payout requirements by “parking” dollars in community foundation funds that have less demanding payout requirements. And foundations are likely to spend less money on reporting and auditing functions, which will make them less accountable to nonprofit organizations, not more.

It gets worse. A big chunk of foundations’ overhead costs consists of fees that some foundations, especially the larger ones, pay their trustees. Nonprofits will suffer if these fees are cut or eliminated. Why? Foundations that pay trustee fees generally get what they pay for.

Trustees chosen for their financial, administrative, or programmatic expertise often give crucial advice and guidance in their fields that the foundation would otherwise have to buy, at a higher price, from employees or consultants.

Perhaps foundations could find just as many talented people to serve on their boards for the equivalent or two or three work weeks per year without offering them any compensation, but experience suggests otherwise. The payment of fees tends to attract capable and dedicated board members, and provides tangible incentives for attendance and fulfillment of responsibilities.

Whenever there is a scandal within the nonprofit world, we rightly hear the question, “Where was the board?” Fees encourage board members to be right where they should be, on the job and paying close attention.

A final punishment that HR 7 would inflict upon nonprofits is that of dealing with less-experienced, less-trained grant makers. There is no such thing as “pre-philanthropy” in college; every person who becomes a grant maker is prepared, by education and experience, to do something else entirely. It is administrative overhead that pays for the training that program officers need in the art and science of grant making. Training programs will be another casualty if HR 7 passes, and nonprofits will soon find themselves dealing with less-capable program officers. And, if foundations, to cut costs, make large grants to intermediary organizations for regranting to nonprofits, nonprofit leaders may soon find themselves dealing with people who have no grant-making experience at all.

Joel J. Orosz
Professor of Philanthropic Studies
Dorothy A. Johnson Center for Philanthropy and Nonprofit Leadership
Grand Valley State University
Grand Rapids, Mich.

To the Editor:

Foundation officials have recently written to The Chronicle to lament the “shrill” nature of the debate around the provision in the Charitable Giving Act of 2003 that would no longer allow foundation overhead costs to count toward the annual 5-percent payout rate.

The Surdna Foundation’s Vincent Stehle is the most recent individual to voice this concern (“Payout Proposal Doesn’t Consider the Long Haul,” August 7), stating, “It’s important that we shift the tone of the debate away from the shrill comments that have pierced the nonprofit world.” The Jessie Ball duPont Fund’s Sherry Magill preceded Mr. Stehle, with “Shrill Debate Over Foundation Bill Puts Some Funds at Risk” (Letters to the Editor) in the July 24 edition.

Their commentaries imply that there have been no sound analyses on the legislation, especially from those organizations and individuals supporting the legislation. In fact, the National Committee for Responsive Philanthropy, one of the leading supporters of increased foundation payout, has extensively analyzed the provision. We have widely disseminated our findings, which were based on analyses of data or research from several different sources, including the National Center for Charitable Statistics, the Internal Revenue Service, the Council on Foundations, the Foundation Center, and Guidestar.

In our first report we very deliberately acknowledged and included reasons why some individuals and foundations might oppose the payout provision in the Charitable Giving Act. We then used data and other existing research to explain why we did not feel that these concerns outweighed the benefits that the bill has the potential to deliver. We wanted to make it clear that we understood that there is not just one side to this debate, which is not something many foundation officials have done when discussing this bill.

Paul Brest, of the William and Flora Hewlett Foundation, has introduced a new “s-word” into the debate, accusing Pablo Eisenberg of using sarcasm instead of sound analysis to argue his reasons for supporting the payout provision. But, sarcastic or not, he only refers to payout studies that support his position and does not mention that there are other analyses that challenge it.

Further, he states that NCRP and others who support the payout provision are “missing some important facts,” which he and his foundation colleagues are “seeking to remedy.”

Although he alludes to some of his concerns about the provision’s potential impact, particularly intimations that the kinds of funding that support NCRP and other progressive advocacy and social-change organizations will be adversely impacted, he does not use any facts or data to support his assertions.

As NCRP’s reports have noted, the small proportion of foundation grant making going to civil rights and social advocacy and other social-justice causes — and the increasing propensity of many foundations to make larger grants to fewer organizations — characterize foundation grant making under current payout requirements, not under an altered payout scenario.

The example of the Hewlett Foundation’s grant to NCRP, which Mr. Brest mentions, is apropos: As he noted, Hewlett funded NCRP despite (and, remarkably, after) an NCRP article (published in The Chronicle) criticizing a Hewlett grant. It was not 5 percent or 6 percent or some other payout formulation that led to the grant; it was, we believe, Paul Brest’s leadership of the foundation and the recognition of our organization’s role in the philanthropic infrastructure.

Mr. Brest, Mr. Stehle, and Ms. Magill are three of the most respected philanthropic leaders we know. Two of the three represent foundations that provide grant support to NCRP despite our differing opinions on this issue and probably others. We hope that the continuing discussion on foundation payout, which preceded the introduction of the Charitable Giving Act and will likely continue regardless of the outcome on Capitol Hill this fall, can be pursued in the civil tones that we hope observers have seen in NCRP’s public statements on the issue.

Jeff Krehely
Research Director
National Committee for Responsive Philanthropy
Washington