The Resilient Sector: The State of Nonprofit America

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Editors’ Note: Lester Salamon’s analysis of the nonprofit sector’s operations over the past 20 years, drawn from the overview to his new book, The State of Nonprofit America (Brookings Institution Press, 2002), is enormously enlightening. Our sector has seen a major shift in its sources of money to earned revenues and consumer-side government vouchers, and an accompanying shift in its internal operations to adapt to the dominant market environment. This growing market culture raises new questions about the nonprofit sector’s role and identity. Is our unique role, which allows ordinary people to associate for public benefit, in danger of being wiped out by commercialization? How have you experienced the trends Salamon reveals? What have they meant for your organization’s mission?
Salamon’s thesis is that nonprofit America has shown a remarkable, although little-recognized, talent for responding to an environment of rapid change—he calls this resiliency. But he also challenges us to ask whether we might simultaneously have lost some ground in terms of our ability to shape that environment—or even perceive ourselves capable of it.

America’s nonprofit organizations have demonstrated enormous resilience in the face of extraordinary challenges over the past 20 years. Yet their responses have pulled the sector in directions that are, at best, not well understood, and at worst, corrosive of the sector’s special character and role.
Like the arteries of a living organism, nonprofit organizations carry a life force that has long invigorated American culture—a faith in the capacity of individual action to improve the quality of human life. Uniquely among American institutions, those in the nonprofit sector blend our commitment to individual freedom with our realization that people have responsibilities that extend beyond themselves, creating a distinctive set of entities dedicated to mobilizing private initiative for the common good.
Nonprofit organizations have confronted an extraordinary array of challenges over the past 20 years, as readers of this journal are doubtless well aware. Significant government funding cuts early in the period followed by shifts in the nature of public support, increased competition from for-profit firms, tepid growth of private giving, a new accountability environment, expanded capital demands stimulated by new technologies, and growing questioning of the legitimacy of the tax and other advantages these organizations have enjoyed are just some of the forces that have been at work.


What is less widely understood, however, is how energetically nonprofits have responded to these pressures. From the evidence at hand, nonprofit America has undergone a quiet revolution over the past 10-15 years, a massive process of reinvention and re-engineering that is still very much underway and that easily rivals the similar changes the business sector has undergone during the same period. To be sure, the resulting changes are hardly universal. Still, there is no denying the dominant impression of extraordinary resilience, adaptation, and change.
On the whole, these changes have strengthened the sector, expanding its resources, strengthening its links with other sectors, and allowing it to do more. But the changes are also not without significant risks, and the risks may well prove more important than the gains unless conscious efforts are made to achieve a better balance between the two.
A Time of Growth: Perhaps the most vivid evidence of nonprofit America’s recent resilience is its record of recent growth. Between 1977 and 1997, the revenues of America’s nonprofit organizations increased by 144 percent after adjusting for inflation, nearly twice the 81 percent growth rate of the nation’s economy. Nor was this growth restricted to health organizations. Arts and culture and social service organizations also experienced especially robust growth. Growth in revenue was matched, moreover, by growth in numbers. During this same period, the number of 501(c)(3) and 501(c)(4) organizations registered with the IRS increased by 115 percent, or about 23,000 organizations per year, compared to a 76 percent growth rate among for-profit businesses.
Competing in the Market: The key to this growth was the success nonprofit organizations have had in adapting to the market. One facet of this was the sector’s ability to attract paying customers for its services. Fee income accounted for 47 percent of total sector growth during this period, 51 percent with religious congregations excluded. Reliance on fee income spread well beyond the fields of health and education where it was formerly concentrated, moreover, into arts and culture and social services. For example, 35 percent of the considerable growth of social service organization income during this period came from this source. (See Growth of Nonprofit Fee Income table.)
Open for Business: In addition to boosting their income from fees, nonprofits have also aggressively pursued a variety of business-type ventures. Examples here include museum gift shops and online stores, church rentals of social halls, and licensing agreements between research universities and commercial firms. Reflecting this, the IRS reports a 35 percent increase in the number of charities reporting so-called “unrelated business income” between 1990 and 1997, and this is just the tip of the iceberg. Perhaps the most interesting facet of this development is the recent tendency of some nonprofit organizations to form “social ventures,” businesses that are designed not simply to generate income, but to use for-profit ventures to carry out the charitable missions of the organizations—build skills, develop self-confidence, and teach work habits to chronically unemployed people.
Coping with the Shift to Vouchers: Equally striking has been the success with which nonprofits have adapted to the new government funding terrain, which has featured a marked shift away from grants and contracts with service producers, toward heavier use of “consumer-side” vouchers, such as Medicare and Medicaid, which channel money to clients, forcing nonprofits to compete for public funds in the market place too. These programs grew massively during the late 1980s and early 1990s, as eligibility and service coverage were progressively extended. With well over 70 percent of an expanded amount of  federal assistance taking the form of such vouchers by the mid-1980s, nonprofits had to learn entirely new ways of accessing public funds. And learn they apparently did.
As a consequence, nonprofit revenues from government have surged, growing 195 percent in real terms between 1977 and 1997, while the overall economy grew by only 81 percent. Here, again, nonprofit health organizations were particular beneficiaries of expanded government support. But they were not alone: social service and arts organizations were also particularly successful in attracting government funds, in each case boosting their government support by 200 percent or more after adjusting for inflation. (See Growth of Nonprofit Revenue from Government table.) Housing and community development organizations were also effective in mobilizing public sector support, though in their case this took the form of exploiting tax incentives designed to leverage private-sector funds as well.
To be sure, not all segments of the nonprofit sector benefited equally from this growth in government support. Medicare and Medicaid are complex systems that are difficult for smaller agencies to access. In addition, reimbursement rates in many of these programs, particularly Medicaid, often fall below the actual cost of providing the services, forcing nonprofits to subsidize government-supported initiatives with limited private charitable support. What is more, the economic recession of 2001-02 and the tax cuts of 2001 seem likely to squeeze reimbursement rates even further in the years immediately ahead. Still, the success with which many nonprofits coped with the significant shift in the character of public-sector support remains an achievement worth noting.
Marketization and Professionalization: Nonprofit America’s adaptation to the market is also apparent in a number of other areas as well. Charitable fundraising, for example, has been significantly reshaped—thoroughly professionalized—and new fundraising technologies developed, such as telemarketing, e-philanthropy, and new “planned giving” instruments. New for-profit companies have also gotten into the act. Indeed, an alternative entrepreneurial model of institutional philanthropy seems to be emerging, modeled on the decentralized entrepreneurial firms that have been the source of much of the new-economy wealth. While these changes have not succeeded in countering the effects of other developments, such as tax and other policies, that have discouraged the growth of giving—causing giving to fall from roughly 18 percent of nonprofit organization income (outside of religion) to 12 percent—they have doubtless boosted charitable giving above what it otherwise might have been.
Substantial changes are also occurring in the basic governance of nonprofit organizations. Boards are being made smaller and more selective, substituting a corporate model for a more community-based one. In addition, the internal structure of organizations is growing more complex. Behind the comforting facade of relatively homey charities, nonprofit organizations are being transformed into complex holding companies, with multiple nonprofit and for-profit subsidiaries, significantly complicating the tasks of operation and financial control.
More generally, nonprofits have increasingly absorbed the culture of the market, incorporating concepts of strategic planning, market niche, performance goals, and entrepreneurship into their basic operations. Furthermore, as they have come to absorb the language of the market, they have become much more attractive partners for businesses. A striking surge of such partnerships has also characterized this period, the other side of the coin of recognition by businesses of their need for “reputational capital” and for a sense of mission compelling enough to attract and hold increasingly mobile employees and customers.
Meeting the Competition: In a number of spheres, nonprofits have also proved able to beat back competition from for-profit firms. For-profits, it turns out, have inherent advantages over nonprofits during growth spurts in particular fields thanks to their access to equity capital through stock offerings. Nonprofits have thus been losing ground to for-profit firms across a broad front.  The nonprofit share of day care jobs, for example, dropped from 52 percent to 38 percent between 1982 and 1997, and similar declines have occurred in other fields as well, such as rehabilitation services, home health, health insurance, kidney dialysis, mental health services, and hospice care. But when government reimbursement rates dip, as they typically do, stock valuations fall precipitously and for-profits begin to cut corners or to retrench. This boom and bust cycle has occurred several times in the hospital industry and among nursing homes, creating opportunities for nonprofits to regain lost ground and demonstrating in the process why the preservation of a nonprofit presence is so critical in sensitive fields.
In addition to meeting the competition in the economic sphere, moreover, nonprofit organizations have also demonstrated an ability to best the competition in the political sphere. This achievement is especially surprising in view of the role that money has come to play in American politics and the legal limitations on nonprofit political action—limitations that bar nonprofit organizations from engaging in electoral activity, from contributing to political campaigns, and from devoting more than a limited share of their resources to lobbying.
Despite these limitations, however, nonprofits have amassed a quite extraordinary record of advocacy achievements, accounting, according to recent reports, for a disproportionate share of Congressional testimony, press coverage of pending legislation, and success in passing the amenities-oriented legislation they have favored, compared to the business lobbies against which they were often arrayed.
Not only have nonprofit citizen groups proved effective in national political advocacy, but these organizations have also recently extended their reach upward to the international level and downward to states and smaller localities. This “third force” is rapidly transforming international politics and economics, challenging government policies on everything from landmines to dam construction, and holding corporations to account in their home markets for environmental damage or labor practices in far-off lands.


Impressive though these achievements have been, however, they have brought with them enormous risks.
Displacing Civic Mission: Most seriously, an identity crisis is being created by the growing tension between the market character of the services the nonprofit sector is increasingly providing and the nonprofit character of the institutions providing them. Nonprofit missions emphasizing quality or service to those in need are particularly at risk as a consequence. This tension has become especially stark in the health field, where third-party payers, such as Medicare and private HMOs, focus narrowly on service cost in setting reimbursement rates. Nonprofit organizations forced to rely on fees and charges naturally begin to skew their service offerings to clientele who are able to pay. When charity care, advocacy, and research are not covered in government or private reimbursement rates, institutions have little choice but to curtail these activities.
All of this has vastly complicated the task of nonprofit management and escalated nonprofit managers’ anxiety about how to balance the need to survive against the commitment to mission that makes survival worthwhile.
Small Agencies at a Disadvantage: These pressures are especially acute for smaller agencies. As successful nonprofit operation comes to require advanced technology, professional marketing, corporate partners, sophisticated fundraising, and mastery of complex government reimbursement systems, the threshold for sustainable operations grows higher. Market pressures are therefore creating not just a digital divide, but a much broader “sustainability chasm” that smaller organizations are finding it increasingly difficult to bridge. Although such agencies can cope in part through collaborations and partnerships, these devices themselves often require sophisticated management and absorb precious managerial energies. As the barriers to entry, and particularly to sustainability, rise, the nonprofit sector is at risk of losing two of its most precious qualities—its ease of entry and its availability as a testing ground for new ideas.
General Public Behind the Times: Popular understanding of these tensions lags badly, however. Thanks to the pressures they are under, and the agility they have shown in response to them, American nonprofit organizations have moved well beyond the quaint Norman Rockwell stereotype of selfless volunteers ministering to the needy and supported largely by charitable gifts. Yet popular and press images remain wedded to this older image and far too little attention has been given to bringing popular perceptions into better alignment with the new realities, and to justifying these realities to a skeptical citizenry and press.
As a consequence, nonprofits find themselves vulnerable when highly visible events, such as the September 11 tragedy, let alone instances of mismanagement or scandal, reveal them to be far more complex and commercially engaged institutions than the public suspects. The more successfully nonprofit organizations respond to the dominant market pressures, therefore, the greater the risk they face of sacrificing the public trust on which they ultimately depend.
This may help explain the widespread appeal of the Bush administration’s “faith-based charities” initiative. What makes this concept so appealing is its comforting affirmation of the older image of the nonprofit sector, the image of voluntary church groups staffed by the faithful solving the nation’s problems of poverty and blight, even though this image grossly exaggerates both the capacity and the inclination of most congregations to engage in meaningful social problem-solving.
Toward a Better Balance: All of this suggests the need for a better balance between the steps nonprofits must take to survive and those they must take to remain distinctive.
Rethinking Community Benefit: As a first step, nonprofits must develop a more coherent statement of “the nature of [their] game.” This will require a serious rethinking of the central concepts of charitable purpose and community benefit that justify the nonprofit sector’s existence. Service to the poor is part of this, but only part. Equally important are the sector’s commitments to reliability and trustworthiness, quality and equity, and the expression of multiple values, opinions, and beliefs. For most Americans, these are powerful and resonant messages but they must be more forcefully and concretely expressed.
Buttressing Public Support: Not only must the nonprofit sector formulate a more coherent defense of its existence, but it also must enlist the public in its defense. This will require a more realistic public understanding of the sector’s current character and role, an understanding that goes beyond the simplistic images of voluntarism and philanthropic support, and that acknowledges the sector’s generally productive partnership with government, and its recent effective engagement of market means to promote nonprofit ends.
Sharpening the Legal Foundations: Changes may also be needed in public policy to make sure that the concepts of community benefit and charitable purpose identified above have effective incentives and reinforcement. This may require challenging the narrow conceptions of charitable purpose as service to the poor embodied in recent legal opinions. But it may also require some tightening of the legal provisions under which nonprofits operate—for example, by policing more stringently the existing unrelated business income tax provisions to ensure that nonprofit organizations pay income taxes on business activities that stray too far from their charitable purposes.
Improving Access to Capital: If promoting the “distinctiveness imperative” of nonprofit organizations is to work, however, steps must also be taken to ease the survival imperative under which these organizations labor.
A first step here would be to correct the structural impediments the nonprofit sector faces in generating investment capital because of its lack of access to the equity markets. More than any other single cause, these impediments explain the difficulty nonprofit organizations have faced in responding to technological change and maintaining their market niche during periods of rapid expansion of demand. A broad nonprofit investment tax credit modeled on the low-income housing tax credit that has allowed nonprofit housing organizations to access private capital would go a long way toward addressing this problem.
Changing Reimbursement Policies: Changes are also needed in the reimbursement policies of third-party payers—private insurance companies, health maintenance organizations, corporate benefit administrators, and government voucher programs like Medicare and Medicaid—which increasingly determine whether nonprofit medical schools, teaching hospitals, and social service agencies can continue to support the critical teaching, research, and charity care that make them distinctive. Blue Shield of California’s recent adoption of an incentive system that takes account of quality, and not just cost, in setting hospital reimbursement rates is promising in this regard, but clearly there is still a long way to go.
Democratizing Charitable Tax Incentives: A significant jolt is also needed to boost the levels of private giving, which have been stuck at under two percent of personal income and declining for two decades. While hardly a panacea for the nonprofit sector’s fiscal woes, one way to do this would be to replace the existing tax deduction system with one based on tax “credits.” Unlike deductions, which deliver more tax benefits per dollar of contribution to upper income taxpayers than to lower income ones, tax credits provide the same tax benefits to all taxpayers regardless of their income.


It has been said that the quality of a nation can be seen in the way it treats its least advantaged citizens. But it can also be seen in the way it treats its most valued institutions. Americans have long paid lip service to the importance they attach to their voluntary institutions while largely ignoring the challenges these institutions face. Now we need to re-examine more seriously—both at the sector-wide level and in individual agencies—whether the balance between survival and distinctiveness that nonprofit institutions have had to strike in recent years is the right one for the future—and, if not, what steps might now be needed to shift this balance toward greater protection of the sector’s distinctiveness for the years ahead. Hopefully, this article will help stimulate that re-examination.

Endnote
This article is adapted from Lester M. Salamon, “The Resilient Sector: The State of Nonprofit America,” in Lester M. Salamon, editor, The State of Nonprofit America, 2002, published by The Brookings Institution Press in cooperation with The Aspen Institute. The book is available from the Brookings Institution Press at (www.brookings.edu), as well as in bookstores and through commercial Web sites.


Lester M. Salamon is a professor at the Johns Hopkins University and director of its Center for Civil Society Studies.