The case for restricting tax subsidies to only the most-deserving charities

Editorial note: this essay originally appeared at The Giving Review.

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What makes a charity a charity? And what makes a charity different than any other nonprofit organization?

Ask most Americans to name a charity and they likely will name a food bank, a homeless shelter, or maybe the local symphony. But the world of § 501(c)(3) public charities also includes roughly 450 organizations with more than $1 billion in revenues, including the Kaiser Foundation Health Plan (2024 revenues of $82.4 billion), the NCAA ($1.3 billion), Battell Memorial Institute ($13.3 billion), the Research Triangle Institute ($1.4 billion), and the Aerospace Corporation ($1.3 billion). None of which recorded a charitable contribution in their latest tax return.

So how do we distinguish between a food bank and a nonprofit that looks and acts more like a Fortune 500 company? And do those that resemble Fortune 500 companies still deserve their tax-exempt status?

One method suggested by Professor Burton A. Weisbrod in his 1988 book The Nonprofit Economy, is a “collectiveness (or publicness) index,” which would classify nonprofits based on the type of revenue they receive and how they use those funds.

In Weisbrod’s words:

This focus on an organization’s sources of revenue is a proxy for the external benefits the nonprofit generates for nonpayers; these, after all, are the benefits to which public subsidies are presumably directed. The point is that the people whose purchases produce “sales” revenue for nonprofits are not financing the same types of activities as are people who make contributions, gifts, and grants.

Thus, “collectiveness” is measured by the percentage of contributions, gifts, and grants (CGG) that an organization receives. The greater the percentage, the more we can consider the organization worthy of a public subsidy through the tax code. By contrast, “the greater the proportion of revenues an organization receives from sales and dues—and, hence, the smaller its collectiveness index—the weaker is its claim for public subsidization, other things equal.”

These latter organizations may be considered “nonprofit,” but they are little different from for-profit firms that produce goods and services that are meant for private consumption.

Using IRS data from 1974 through 1977, Weisbrod ranked the types of nonprofit organizations based on their collectiveness score. The types of organizations that scored the highest (with donations greater than 50% of their revenues) were those that focused on legal aid, civil rights, and inner-city community development. At the other end of the spectrum, organizations that had the lowest “publicness” score (with donations less than 10%) were those that relied largely on membership dues or fee-for-service income. This included mutual associations, sports and social clubs, business groups, and health organizations.

But that was 50 years ago. To see how much the nonprofit world has changed since Weisbrod’s snapshot, I performed a similar exercise using 2021 IRS data for 501(c)(3) organizations curated by the Urban Institute’s National Center for Charitable Statistics. The results are illuminating.

The table below lists (c)(3) organizations according to the 26 classifications in the National Taxonomy of Exempt Entities (NTEE). Some were not classified, so I gave them a 0 (zero) classification. The categories are sorted according to the percentage of donative income they receive, from highest to lowest.

At the top, the organizations that Weisbrod would say have the highest degree of “publicness” include those involved in providing food and nutrition services, philanthropy and grantmaking, civil-rights, religion-related, and environmental programs. Interestingly, there are only seven categories of nonprofits that receive more than half of their income from donations. In general, they receive little in the way of program income or government grants.

At the other end of the spectrum, the organizations that show the least amount of “publicness” are those that rely almost exclusively on program income and very little on gifts and government grants. According to this metric, the health-care sector is the least “public” of all nonprofit categories. Ironically, it is also the largest nonprofit sector, with more than $1.3 trillion in total revenues, comprising fully half of the $2.6 trillion in total revenues generated by the nonprofits in this dataset. Moreover, 89% of health-care revenues are derived from program income, while donations account for only 2%.

The other two categories with single-digit donation percentages include mutual and membership organizations and those providing mental-health and crisis intervention. Both of these groups receive 60% of their revenues from program sources—either in the form of membership dues or fee-for-service income—although mental-health organizations also rely substantially (28%) on government grants.

Even within these extreme cases, there are significant variations within each category. Within the health-care sector, for example, there are multibillion-dollar health-insurance firms, such as Healthfirst PHSP in New York City, that receive no donative income, as well as small health clinics funded entirely by donations, such as Crew Community Health in Orlando, Fla. Similarly, in the food-service sector, there is the Billings Food Bank, which is nearly 100% funded by donations, as well as the Florida Foundation Seed Producers, which is roughly 98% funded by program income and reports no donations.

Because of these variations, Weisbrod concluded that “The collectiveness index (CI) is not a flawless indicator of an organization’s external benefits and so it is not a perfect basis for public subsidization.” Maybe so, but there are two reasons lawmakers should use a tool like this to shrink the number of organizations worthy of a taxpayer subsidy.

First, nonprofits currently generate $2.8 trillion in business income that is largely exempt from the unrelated business income tax (UBIT), but should be taxed. Second, given the need to address the nearly $30 trillion national debt, it is imperative that subsidies through the tax code be judiciously handed out to only the most-deserving nonprofit organizations.

Lawmakers who criticize corporate welfare for publicly traded corporations should be just as concerned about corporate welfare for large nonprofit enterprises. Taking them off the dole would be good for tax fairness and the nation’s finances.

Source: https://capitalresearch.org/article/the-case-for-restricting-tax-subsidies-to-only-the-most-deserving-charities/