The Ironies of Foundation Regulation

As Congress gets back to work, legislation on charitable giving will struggle to command attention from lawmakers focused on the 2004 elections. But few members of Congress remain focused on reining in foundation spending on administrative expenses and seeking ways to encourage grant makers to award more to charities.

As foundations and charities prepare for the possibility that Congress will again focus on this issue in the coming months, it is worth having some perspective on just how significant and unpredictable even a relatively minor reshaping of federal law governing foundations can be. What is clear by looking at the historical record is that Congress has little, if any, idea what the consequences will be when it tries to regulate the world of philanthropy.

Perhaps no law has done more to influence modern philanthropy than the Tax Reform Act of 1969. The law came after revelations of financial abuses at a few small foundations — and the distribution of some politically controversial grants by some of the nation’s largest foundations — caught the attention of Rep. Wright Patman, a populist Democrat from Texas, who in 1961 started what would become an eight-year inquiry into the grant-making and management practices of foundations. Many foundations today have displayed some of the very same kind of behavior that has prompted lawmakers to put grant makers under scrutiny and most recently led some members of the House of Representatives to propose a change in the rules for counting how much a foundation gives to charity each year. Under the plan, foundations would no longer be able to count administrative assets, such as salaries and office rent, when figuring out whether they meet federal requirements to distribute at least 5 percent of their assets to charity each year.

The 1969 law not only created the payout minimum, but it also levied an annual excise tax on foundations’ net investment income, prohibited sweetheart financial arrangements and other types of “self-dealing,” limited how much of a company a foundation could own, and put in new requirements for how much information grant makers must disclose to the public.

Such changes were important, but they appeared at the time mostly dry, technical, and legalistic in character. However, few in philanthropy took it that way, and for a world used to operating freely, the 1969 regulations were viewed as painful punishment and prompted profound changes that have altered how philanthropy works.

In an effort to defend philanthropy from further government investigation and regulation, foundations strategically recast themselves in the 1970s. No longer did foundations want to be seen as organizations that operated privately to carry out the desires of the donors who created them, but they instead sought to be viewed as public trusts. By becoming more transparent, adopting professional standards, and following codes of ethics, foundations set about trying to counter the most damaging charges that they had faced, namely that they were elitist organizations, secretive in their work, and out of touch with the communities they were supposed to serve.

Perhaps just as important, the newly transparent foundations of the 1970s and 1980s discovered that they needed new staff members to manage their increasingly complex external relations. Foundations began to look for increasingly specialized skills in their leadership and staffs, instead of relying so much on the academics and others who had ended up in the grant-making field by happenstance. As a result, one of the most obvious changes within private foundations in the 1970s occurred on the balance sheet: The new regulations drove up administrative costs and reduced the proportion of foundation assets going to charity. Administrative overhead in foundations rose from 6.4 percent in 1966, before regulations were passed, to 14.9 percent in 1972, where it has hovered ever since.

Gone today is the simple administrative structure that enabled large foundations in the early part of the 20th century to act quickly and decisively in response to directions from the founder. In its place is often a complex administrative bureaucracy staffed by a new cadre of foundation professionals, frequently with multiple approval levels through which grant decisions must travel.

Not only did foundations hire professionals to handle communications with grant recipients and the public, but they also spent more on lawyers, accountants, and other professionals whom they hired to ensure that they would not get in trouble with lawmakers ever again. Foundations have grown into profoundly public institutions, open and transparent to all. Far from shying away from publicity, grant makers began to seek out opportunities to explain and advertise their work to anyone who will listen.

These fateful steps, taken decades ago, continue to cast a long shadow over the field of philanthropy. The move to define philanthropic institutions as public trusts operated for public purposes has had the effect of putting a significant crimp on the ability of institutional donors to engage in idiosyncratic, iconoclastic, and deeply personal forms of large-scale giving. With professionalization, many large foundations have moved to the soft and safe center on pressing social problems.

With Congress again looking at foundations and beginning to ask tough questions about their management and their generosity, the shadow of the Tax Reform Act of 1969 and its aftermath looms large. While Congress ultimately didn’t pass the measure proposed last year to exclude administrative expenses from the payout calculation, the House and Senate did agree to limit certain types of payments from being counted — such as first-class airfare — as part of a comprehensive charity bill that got stuck in a legislative bottleneck and died.

As the news media continue to report on questionable foundation outlays — such as the Mercury News, in San Jose, which reported on the $700,000 paid to the Irvine Foundation’s former chief executive, Dennis Collins, or The Boston Globe series coverage of lavish foundation spending on perks and board fees — it is likely that Congress will look at administrative expenses more closely.

When lawmakers do that, they should look behind the headlines and a few disconcerting anecdotes to the broader issue of overhead expenses. Congress will find that foundations expanded their staffing and increased their costs over the past three decades precisely because they were charged with being insufficiently accountable and ineffectively managed. In this sense, the current focus on abuses in a small number of foundations distracts from where this debate started, namely whether foundations could and should spend more on grants and less on overhead.

Given this, the painfully ironic question that now looms large is clear: Do lawmakers want to punish foundations for changes that Congress itself unintentionally ushered in by regulating the field 30 years ago, or should it be more thoughtful as it approaches the question of how best to make philanthropy a force for good in our society?

The sad part of this story is that foundations could probably avoid political scrutiny now and in the future if they simply dealt directly and honestly with deep-seated questions about whether they are making a difference to society. Instead of dreaming of overhauling the field through clever new rhetorical moves or defending it with dire predictions of extinction, foundation leaders need to take seriously the challenge of doing good work that leads to visible outcomes, and being not just transparent, but truly open and accountable. That would be the best long-term solution to the strange and ironic quagmire that now besets the world of foundations.

Peter Frumkin teaches at Harvard’s John F. Kennedy School of Government, where he is affiliated with the Hauser Center for Nonprofit Organizations. He is the author of

On Being Nonprofit (Harvard University Press, 2002) An extended discussion of some of the issues raised here can be found at http://www.hudson.org/files/publications/FrumkinMonograph.pdf.