Foundation Fury

Private foundations are roiled, agitated and mobilized about a tiny provision of the Charitable Giving Act of 2003. Section 105 of HR 7 would do two things. It would reduce and consolidate to 1 percent the two-tier federal tax private foundations pay on their net investment income, and it would exclude from private foundations’ required “qualifying distributions” all general (administrative and operating) expenses. The bill breaches the bottom-line public policy issue for foundations by proposing to alter the amount and composition of private foundation “payout.”

Because there is no comparable payout requirement on the endowed wealth of public charities or public foundations, Section 105 affects the spending from the nearly $500 billion in private foundation endowment assets but leaves untouched the $800 billion or more in nonprofit endowments controlled by public charities such as universities, community foundations and donor-advised charitable funds.

Most nonprofits are unaware that foundation benefactors include more than the grants “payout” in their foundations awards. Private foundations can and do include a variety of other expenses, such as executive salaries, fees paid to foundation trustee board members, travel and meeting expenses, office rental and development costs, printing, publications and professional fees.

Many large foundations feel targeted by the bill, which has provoked an examination of the composition of their charitable expenditures. Based on an IRS report from 1999, 521 out of 58,840 private nonoperating foundations accounted for 51.3 percent of payout-related general expenses, making their grants payout roughly 4.1 percent of their assets, not 5 percent. In 2001 all private nonoperating foundations included 47 percent of their administrative and operating costs in their payout, but the 100 largest foundations included 62 percent of their nongrant expenditures in their qualifying distributions.

The murky world of foundation operation has now reached the press, with increasing coverage of excess compensation practices and particularly lavish fees paid to foundation trustees, and lodged itself in front of the House Ways and Means Committee, chaired by Bill Thomas (R-CA). After introduction of HR 7 in May, editorials in favor of the legislation quickly appeared in USA Today, the San Jose Mercury News and the New York Times.

For some foundations, this is a nightmare scenario. Some of the very largest foundations have retained former Republican Congressman Bill Paxon, representing the Republican wing of the Beltway lobbying firm Akin Gump, to convince his former Republican colleagues to scotch the legislation. Nonprofit supporters of HR 7 are generally silent, terrified of speaking out on the legislation and facing grant terminations by angry funders. Concern also stems from speculation that this is the first step in regulating general expenditures of all nonprofits, not just private grantmaking foundations.

Possibly by the end of the summer, some version of HR 7 will have emerged. By fall, the House and Senate conference committee may have to decide if a foundation payout-related provision will make it into the bill that goes before the president. As the House and Senate thrash this out, they will have to sort out the arguments pro and con:

Will Section 105 stop foundations from spending money on staffing, technical assistance and due diligence? The legislation does not stop administrative expenditures, but merely excludes them from qualifying distributions, making foundation payout an apples-to-apples comparison. In an odd paradox, some of the large foundations vociferously criticizing Section 105 as an attack on foundations’ administrative spending are the same foundations whose policies prohibit grants to nonprofits for general operating costs or zero out the overhead or indirect cost lines in nonprofits’ project grant applications. Foundations can cover operating costs by giving themselves a grant; few nonprofits have that option at their disposal.

Will this change force foundations to spend themselves out of business? If all grantmaking foundations’ general expenditures were excluded from foundation payout, replaced with grants, and then added on top of payout, the result would be a spending increase of about 0.4 percent. The financial catechism of the Council on Foundations indicates that a compulsory spending rate above 5 percent will drive foundations to spend themselves out of business. There are many who would say that is bogus.

Is Section 105 really a right-wing plot to “defund the left?” With foundation grant making for civil rights plunging in 2001 to 1.1 percent, to 3.7 percent for community development, and hovering at infinitesimally low levels for other indicators of social change and justice, the picture of private foundations as “the left” is difficult to absorb. Moreover, conservative foundations have not endorsed Section 105, in part because some conservatives believe in no regulation and consequently no payout requirement at all.

Has the stock market tanked so badly that foundations cannot sustain a payout rate higher than 5 percent? The foundations’ creed according to the Council is that foundations need a 9.5 percent return on investments in order to make a 5 percent payout rate plus keep the buying power of their endowments growing ahead of the cost of inflation. The past three years of down market returns underscores their concerns against the previous two decades of skyrocketing equities. Studies pro and con debate the investment return question, but the foundations virtually never acknowledge that in addition to investment returns, foundations receive other resources.

According to 2002 data, 45 percent of private foundations received new grants or gifts. In addition, foundations earned another $1.9 billion from noninvestment revenue and an additional $300 million from rental income. There is money flowing into philanthropy even when the stock market is down.

If Section 105 is enacted, it will not solve the capital problems of the nonprofit sector alone. It might amount to new foundation grant making of upwards of $3 billion, not much in the scheme of all nonprofit finances, but as Everett Dirksen once said, “A billion here, a billion there, sooner or later it adds up to real money.” It will not replace lost resources due to depressed charitable giving and retrenched government budgets, but it will potentially unleash some funding that unnecessarily languishes in foundation endowments that could and should be in the hands of the nonprofits on the front lines of addressing this nation’s most critical problems.

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