The Nonprofit Sector’s Downward Slope: How Steep and How Long?

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Just as no one knew where in the cycle they were at the top of the boom in January 2000, no one knows now how steep or how long the nonprofit sector’s downward slope will last.

Despite naïve late-90s hopes for an end to the business cycle of alternating growth and recession, the U.S. economy (and most of the world’s) is in the midst of major reversal—now hitting the nonprofit sector with full force.

After ten years of steady financial growth, nonprofit organizations are facing a major retrenchment. As was the case in the last two economic downturns, nonprofits are experiencing the recession a year after the rest of the economy, and are likely to stay in recession two years longer (see “Lag-effect” graph, page 24). Even while the Federal Reserve is detecting signs that the U.S. economy is on the brink of recovery, nonprofit organizations in almost every activity area are in a steep slide.
How steep the slide is, in fact, is hard to say since nonprofit organizations lack ready access to economic performance information (unlike virtually every other industry in the U.S.). While the departments of Commerce, Agriculture and Labor collect statistics in specific industries, the economic activity of nonprofits is tracked once a year through IRS Form 990, filed four and a half months after the end of the fiscal year, and somehow tabulated on a national level a year or two later.
In place of accurate industry-wide information, nonprofits are piecing together the story organization by organization—with major doubts about what the future holds, or what next steps to take. The dramatic decreases in funding and loss of reliability for remaining revenues have created the most challenging climate nonprofits managers have faced.

In retrospect, the period between 1991 and 2001 can be appreciated nostalgically as the longest period of post-war economic expansion in American history—and a great time to grow a nonprofit organization. The boom increased state government receipts, making possible both modest expansions in state services (often in contractual relationships with nonprofits) and $35.7 billion in state tax cuts. The optimism of this period was that states could do it all: cut taxes, increase investment in the arts and education, and support childcare and job training to give welfare reform a realistic chance of success.

The stock market rise grew foundation endowments—grants went up by 132 percent from 1992-2001 for private foundations and 200 percent for community foundations (constant dollars). Organized philanthropy’s historic role as the funder of the new and innovative made sense in a rapidly expanding economy, new projects could be reasonably expected to find continuation or replication money elsewhere, from government, other funders, or as social enterprises.
A new set of nonprofit managers was coming of age, mastering the complex art of growing budgets, diversifying income, upgrading facilities and improving salaries. The problems that existed, such as being priced out of commercial office space in San Francisco and Boston by dot-coms, were symptoms of a pleasant though “irrational exuberance”—nonprofit life was good!

While the formal start of the recession has been pegged as March 2001, it will be forever associated with the events of September 11th. The terrorist attacks on New York City and Washington, D.C. staggered the economy, and at the same time inspired unprecedented charitable contributions—over $2.7 billion for victims and their families. Early fears of a massive diversion undercutting annual charitable goals around the country proved to be overblown—only one percent of all 2001 U.S. charitable contributions went to 9/11 victims.

As the economy shed three million jobs, massive layoffs in technology, manufacturing, airlines, and tourism had ripple effects on retail, services and government. Enron and Worldcom accounting frauds and stock collapses in 2002 pushed the Dow Jones Average below 10,000 points, and consumer confidence sank further.

Nonprofit organizations, many with funds allocated one to two years in advance, slowly began to feel the downturn. Colleges and universities saw their endowments shrink, organizations with capital campaigns had to reassess the timing and size of their goals.

Every state except Wyoming (which benefits from higher natural gas prices) has a deficit, or expects one next year. When the Urban Institute examined how states are responding to fiscal stress, it found that for the 2002 budget cycles, states expected more revenue than they had in the prior year—not surprisingly, in a recession, this proved to be overly optimistic.
To deal with 2002 deficits, states used a similar set of strategies: drawing down reserves, using one-time cost shifts, and securitizing (selling off) tobacco settlement funds—minimizing budget pressure in the short term, but increasing the pressure for future fiscal years.

By 2003, with state deficits up another $100 billion and the reserves spent, states were left with unpopular choices between increasing revenue by raising taxes or cutting spending. In virtually every state, political pressure was organized by anti-tax groups to keep revenue-raising options off the table. Cutting services was left as the major tool, especially Medicaid, childcare, child welfare, youth programs, arts, local government aid, layoffs of state workers, and cuts across the board.
“The funding climate is one of retrenchment,” says Irv Katz, president of the National Assembly of Health and Human Service Organizations. “Thanks to state budget shortfalls, federal policy that favors tax cuts over human needs and community development, and reduced individual, corporate and foundation giving. We’ll weather this storm—or series of storms—but the short-term outlook spells cutbacks and un-met needs.”

Arts funding was judged a politically easier area to cut, with state funding reduced in almost every state—32 percent in Minnesota, 41 percent in California and 62 percent in Massachusetts. Arizona and New Jersey considered eliminating all state arts funding, but settled for budget cuts instead.

The federal government’s ability to deficit-spend gives it more budget-maneuvering room than the states. This year’s $350 billion federal tax bill (which exempted dividends from the income tax but left low-income children out of increased federal tax credits) included $20 billion in relief for the states. This amount played a key role in state efforts to preserve healthcare eligibility for low income and disabled people, and most states allocated the money within a week of passage.

Obviously, more federal revenue sharing would be helpful, but as Jeff Madrick makes clear in his article (see page 16), there is little appetite, or room in the current federal agenda, to provide substantial aid to the states. The good times projected by the Congressional Budget Offices in January 2001—$5.6 trillion surplus over 10 years—have been replaced by 2003 record deficits of $400 billion per year.

What’s next for the states? Barring a miraculous economic recovery, more cuts. State legislators overwhelmingly expect at least two more years of terrible budget problems, reported a May 2003 Pew Center on the States survey of state legislators. Most legislators believe further cuts in services are likely—85 percent predict deeper cuts in social services, and 71 percent of the lawmakers polled expect more cuts in healthcare.

State and local government face both a trying economic picture and more difficult political climate. State legislatures are increasingly polarized, caught between limited-government crusaders campaigning to “starve the beast” and labor and community advocates making the case for specific services and community needs. Grover Norquist, head of Washington-based Americans for Tax Reform (which supports all tax cuts and opposes all tax increases as a matter of principle), works with state groups to get candidates and elected officials to sign the anti-tax pledge:
“I (name) pledge to the taxpayers of the (district #) district, of the state of (state), and to all the people of this state, that I will oppose and vote against any and all efforts to increase taxes.”

Norquist is quoted by Bill Moyers as declaring that “We are trying to change the tone in state capitals—and turn them toward bitter nastiness and partisanship,” which he feels will be more amenable to the anti-tax message, and defines bi-partisanship as another name for “date rape.”

One exception to keeping tax increases off the table is Alabama, where the state’s tax structure has been more punitive on poor people than almost any other state. Republican Gov. Bob Riley stunned conservative supporters by pushing tax reform through the legislature, using the moral argument that Christians are prohibited from oppressing the poor. Changes to the states tax code, which still must be ratified by voters, would reduce income taxes on low-wage workers and increase taxes on wealthy individuals and timber corporations such as Weyerhaeuser.

After the Iraq War news cycle ended, bad news about state budget deficits became a staple of local news coverage. Washington Post columnist David Broder observed, “The public pessimism, which has been blamed for the sluggish economy, is directly related to the plight of state and local governments. People in states such as Oregon and Indiana are being battered by daily television bulletins and newspaper headlines reporting that the governments closest to them are being forced to take actions that threaten their quality of life.”

Worry about the economy influences the public’s willingness to make charitable contributions, especially small and medium-sized contributions. When people are concerned about their personal finances, their overall giving can go down by a third, says a new report by Independent Sector, Giving in Tough Times: The Impact of Personal Economic Concerns on Giving and Volunteering. IS reports that households with incomes more than $75,000 in this situation decrease their giving by 33 percent, from over $3,600 per household to less than $2,500, and households with incomes between $50,000 and $75,000 decrease their giving by 32 percent, from $2,030 to $1,390.

Reflecting this anxiety, organizations across the country are reporting flat or decreased contributions, and most United Way fundraising campaigns are falling short:

• The United Way of Central Maryland cut funding to 63 nonprofits by 40 percent for at least six months due to a shortfall in donations; seven larger organizations in the campaign (including the American Cancer Society, American Red Cross and Associated Catholic Charities) will be cut only 12 to 13 percent because they have contractual guarantees.
• A decrease in donations to the Pitt County United Way, Greenville, N.C., has forced the organization to cut funding to many of the human-service agencies it supports. Officials mailed letters at the end of last month informing nine of 25 agencies they would receive cuts that averaged 10 percent.
United Way of America spokesman Phillip Jones says, “While we haven’t released figures for 2003, all indications are that the overall campaigns are down four to five percent for the year, due to the down economy, employment and stock market. It’s hitting every geographic area—some tourism areas are worse—but we expect the following year to be better.”
A survey by the Bay-Area United Way shows how local nonprofit organizations are experiencing the decline in overall charitable giving:
• 68 percent reported a decline in corporate, foundation or institutional gifts.
• 60 percent saw a decline in individual gifts.
While current information on individual donations is hard to come by, twice a year the Center on Philanthropy at Indiana University conducts a Philanthropic Giving Index (PGI) survey, which estimates current trends and future expectations in U.S. charitable giving. The latest survey reports more bad news, at least as seen by the people responsible for raising money: fundraisers are less optimistic about the charitable-giving climate than they were last year or even immediately after September 11th. Eighty-five percent of fundraisers surveyed said the economy is having more of a negative impact on fundraising efforts than it was six months ago.

“We know from our other research that the changes in the Standard & Poor’s 500 Index is one of the best predictors of change in individual giving,” said Patrick M. Rooney, an economist and director of research at the Center on Philanthropy. “The S & P went down slightly this spring and has only recently improved. The market fluctuations seem to be a case of “too little, too late” to have had a positive impact on the perceptions of the fundraising climate.”

The delayed effects of a recession are more pronounced in the private foundation world, where federal law obliges foundations to spend approximately five percent of the value of their assets for “qualifying distributions” (grants and administrative expenses). As foundation assets go up and down, so do grants—but not immediately.

Reduced assets are a new experience for most foundation managers—2001’s 3.8 percent aggregate decline in assets of U.S. foundations was the first since 1981, while surveys show a 10 to 12 percent decline for 2002.
Foundations more heavily invested in the tech sector, such as the Packard Foundation, have seen greater losses. According to the Chronicle of Philanthropy, Packard’s assets dropped to $5 billion from a high of $17 billion in 2000—losing $3.6 billion in 2001 alone. The foundation also cut 60 staff positions and eliminated its entire organizational effectiveness program. Finally, Packard slashed its grant making from $451 million in 2001 to $250 million in 2002, saying it will give only $200 million in 2003. Also suffering from weak stockholdings, the AOL Time Warner Foundation closed its Dulles, VA, office and laid off most of its 20-member staff.

In addition to Packard, four other foundations have seen billion-dollar-plus assets losses: Starr (-$1.5), Lilly Endowment (-$2.8), Ford (-$3.8) and the J. Paul Getty Trust (-$1.7).
Like state legislatures, foundation boards face the problem of how to allocate their cost reductions: across-the-board program cuts, elimination of specific programs, or exceed the five-percent pay-out?
Congress stepped into this situation with a proposal to increase payout by excluding administrative expenses from the required five percent qualifying distribution requirement for private foundations. The Charitable Giving Act of 2003 (HR 7) in the House—named the CARE Act in the Senate—would reduce the excise tax on private foundation investment income to a flat one percent of investment income, and would also change the calculation for payout by excluding the foundation’s administrative and operating expenses from the definition of “qualifying distribution.” The Council on Foundations opposes this change, arguing that increasing payout would force foundations to spend more than their investments produce, effectively ending the perpetuity of their charitable endowments.

A longtime advocate for increased payout by foundations, the National Committee for Responsive Philanthropy, challenges the Council’s assertions that a minor increase in the grants payout of foundations would undermine perpetuity. NCRP supports the provision of HR7 on foundations’ qualifying distributions, asserting that, “private foundations can afford to devote up to an additional $4.3 billion annually to nonprofits while sustaining themselves for the long term and enhancing their own efficiency.” The total increase in foundation payout, were foundations to replace all payout-related operating and administrative expenses with grants and then continue the same administrative expenditure levels, would amount to 0.4 percent or less, a minor increase that makes contentions about foundations spending themselves out of existence far-fetched.
Grants will probably be depressed into 2004 and 2005 even if foundation assets begin to recover their value, since the five percent qualifying distribution calculation is based on a rolling five-year base period. (This calculation by private foundations is made at Part V of IRS form 990-PF, which can be seen for any foundation at
Regardless of how Congress deals with the payout issue (and some sort of compromise excluding a number of administrative expenses is very possible), organized philanthropy still faces an identity crisis over its current role. No one believes that governments, foundations or earned-income can sustain, replicate or expand current special projects, so what becomes of the thousands of new and innovative projects? (See “From Funders to Funders,” where three foundation executives address this question, page 44.)

The full effect of so many revenue losses across the nonprofit sector will not be known until later, after state and local budget decisions are translated into harder (and harsher) numbers. The collective impact of so many reductions at once poses another major question. Here are some examples of the consequences for local communities of these simultaneous reductions in eligibility for people that need services, and decreased resources in the organizations that serve them:

• 275,000 Texas children were dropped from medical coverage.
• Lutheran Social Services of the National Capital Area ended programs and reduced staff from 130 to 50 to cope with a 40 percent loss of funds.
• 47,000 Florida children are on waiting lists for childcare.
• Seven Boys and Girls Clubs of the Twin Cities (Minnesota) closed on Fridays this summer and there was a 20 percent pay cut for the organization’s 120 employees.
The losses are so widespread yet individual that they are impossible to catalogue. This is where the fragmentation and lack of current information keeps the field in the dark, and makes the management task more difficult. (Hopefully, the Nonprofit Listening Post project, recently unveiled by the Center for Civil Society Studies at Johns Hopkins University, will address this information vacuum.) The next two years will sorely test the resiliency of the nonprofit sector, and require tough decisions from the boards, managers and the supporters of each organization.

We know that substantial numbers of organizations will dissolve, and others will merge. Organizations that depend on earned income will have to more closely manage each revenue center to make sure they make their numbers—and be prepared to act quickly if they don’t. A larger number of organizations will operate at a flat or smaller size for a time, waiting for the economy to recover.

For surviving and growing organizations, the world will also look different because whole sections of essential community services may be lost, depending on shifts in funding. Within the shrinkage of collateral services, some of which an organization has relied on (such as a work skills training center that has relied on the fact that job training participants were eligible for healthcare), a new round of planning and assessment is in order.

In retrospect, organizations might have acted differently if they knew they were in an economic bubble, but who knew? The management challenge now will be to stay abreast of indicators, assess what’s going on in the community around the organization, and to take the long view beyond the current cycle.

Jon Pratt is a contributing editor with the Nonprofit Quarterly and executive director of the Minnesota Council of Nonprofits.