Aligning tax benefits with public benefits

Its always helpful to leave one's comfort zone to gain a new perspective. So, here I am in Berlin, wondering about the American tax system and its support for charitable activities.

And here's a thought - we should align the tax benefits for charitable giving with the amount of money that actually goes to charity. For example, the full corpus of an endowment is exempt from taxes, even though most foundations only spend a small percentage (around 5%) of their endowment earnings on charitable purposes. So the actual tax benefit ought to align with the charitable dollars - the 5% given in grants, not the 100% of the endowment which is in market rate investment vehicles.

If endowment managers can demonstrate alignment between their investment policies and their charitable missions, then the tax benefit would be extended to those investments. If a foundation invests 10% of its corpus in companies that serve a public benefit purpose in line with the foundation's mission, then the tax exemption would extend to include the 5% it pays in grants and the 10% of its endowment that it is using to achieve its mission. The other 90% of the endowment would be taxed.

After all, why are taxpayers subsidizing market-rate investment capital? Shouldn't public benefit tax exemptions be granted for public benefit activities?


Nick said...

Are there any standardized evaluation instruments to assess the alignment of investments with charitable purposes / public interest / public good? Would the standard be self-referential or broad enough to encompass any legal charitable purpose?

Peter Manzo said...

"After all, why are taxpayers subsidizing market-rate investment capital?"

This is a great question. Sounds like you've already proposed the answer, that we shouldn't, that we should compel or encourage foundations to use their endowments for broadly public benefit purposes. I agree, and would raise one or two other ways to do that, but before getting to that, another opposing answer to the question is that maximizing returns to the endowment means maximizing grants paid out, and that taxing returns would mean diminished payout.

In addition to taxing non-aligned investment returns, might there be other intermediary ways to get at this? Imposing an excise tax (distinct from standard corporate tax)? Increasing payout requirements for foundations that are not using aligned investing (turning the non-aligned investing argument on itself - if unrestricted investing leads to higher returns over time, then you should be able to handle higher payout rates)?

Steve said...

If there is to be a tax on the principal corpus why would anyone set up a founation to begin with. If they had pure charitable interests they could do this under present tax law and receive similar tax deductions with the exta effort of a foundation.

One needs to remember that the primary purposes of a foundation are to provide 'higher risks grants' that would not be fundable either by government sources or by annual deductable gifts from taxable personal income.

Also foundations exist to provde long term sustainable funding for research and arts that would not otherwise be able to secure funding except from governement sources.

For instance it was the long term funding from the Ford Foundation that brought us Public Broadcasting - which is now mostly reliant on contiued privatre fund raising.

Anonymous said...

Apparently you do not fully understand endowments. When taxpayers make gifts to endowments, they are relegating exclusive legal control to a 501(c)(3) public charity, which, in and of itself represents a charitable contribution deductible to the maximum extent allowed under the law. Endowments are important planning tools of philanthropy; and investment income earned is also dedicated to the charitable cause being addressed. There is no one reaping any personal benefit from those dollars which are dedicated to providing for necessary philanthropic practices in the future. How grateful we all need to be to those taxpayers who give away their assets to public charities who then have exclusive legal control of the assets to prudently invest them solely for the sake of philanthropy. Under your plan, are even non-endowed gifts for any charitable purpose that are not spent in the current year, either intentionally or by circumstancial dictation, also, therefore, not fully deductible at the time of the gift? What an incredible waste of time it would be to track that process (if not a completely impossible one). The bottom line is that, when the taxpayer gives his or her money to charity, they have given away an asset and the future earnings on that asset; there is absolutely no reason to deny them a tax deduction for their magnanimous actions.

Pete said...

Sounds to me like Lucy understands endowments extremely well, in fact. The question here isn't the value of the deduction to the donor at the time the endowment is created, it is what obligations are imposed on the management, not just the expenditure, of those funds. If the assets are not invested in ways that are not at least striving for social benefit, they are at best tax-subsidized deferrals of energy that could be put to good use now. If they were to be expended, rather than warehoused, they would be obligated to be spent for social benefit. Why not, then, use the same public benefit test for their management, so far as possible? There may be good reasons for holding endowment funds for the long haul (maybe even perpetuity), provided that they are spent in much smarter and strategic ways at the 5% rate over time than they would be if spent much sooner - this was the key point made by Michael Porter and Marc Kramer. A better objection would be the difficulty of measuring whether endowment funds met that test - the IRS tried to do this years ago in trying to limit the eligibility of foundation admin expenses as part of a foundation's minimum payout.