Nonprofit Economy Update: More Money for More Organizations (But Maybe Not for Yours)

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Like many things, the schizophrenic state of the nonprofit economy depends on where you sit. For nonprofit hospitals and higher education, the big picture is growth across the board. For arts and culture, human services, neighborhood and community organizations, environmental and civic organizations—not so simple.

170 years ago in Democracy in America, Alexis de Tocqueville wrote that as conditions in democracies became more equal, more associations (nonprofits) and more newspapers would be formed—required to facilitate cooperation and joint efforts among citizens. Unfortunately, at least in this instance, Tocqueville is wrong. To the extent that equality of conditions is defined by distribution of income and assets, since 1970 in the United States the number of nonprofits has increased at the same time inequality has increased.

While only a third of U.S. nonprofits are primarily engaged in direct efforts for relief of the conditions of the poor, the larger segment of organizations also encounters public expectations that they will make price adjustments to increase access to services for the poor. Recent lawsuits and congressional investigations into hospital charity care policies illustrate the classic squeeze of cross-cutting expectations—to be simultaneously market- and business-oriented, and to serve as a correction to the ills of the marketplace by providing free or reduced cost services.

Nonprofit hospitals and health organizations, representing 60 percent of nonprofit financial activity and a large part of its recent growth, are being investigated by two congressional committees with jurisdiction over the IRS and federal tax exemptions: House Ways and Means and the Senate Finance. In May, Senate Finance Committee Chair Charles Grassley sent the kind of letter no one wants to receive to 10 nonprofit hospital organizations:

Dear [Hospital CEO]:

The Congress is considering issues of tax-exempt organizations and particularly the duties and requirements of public charities in relation to the billions of dollars in tax benefits that tax-exempt organizations receive at the federal, state, and local level. To assist the Congress in this review and determination of actual practices in the field for tax exempt hospitals, I request the following information . . . .

The six-page letter goes on to present 25 detailed questions and document requests on “Charity Care and Community Benefit,” and 21 questions and document requests on “Payments/Charges/Debt Collection/Tax-Exempt Status and Other Issues,” including:

What are the 10 largest categories of charity care expenditures incurred by your hospital for the past five years? How does this differ from 10 years ago? 25 years ago?

Please explain what is the economic benefit to your hospital of charging uninsureds the high chargemaster rate when uninsured people generally have less of an ability to pay hospital charges and do in fact generally only pay a fraction of what has been charged? Does this benefit justify your action particularly in light of your not-for-profit tax-exempt status?

Please provide for the last three years a detailed breakdown of travel of your five top salaried employees: for trips over $1000 please provide receipts for hotel; meals; airfare and all other reimbursed items as well as the purpose of the trip. Please provide all salaries and other benefits provided to these individuals for the last three years from any organization identified in [previous questions]. Finally, please detail any payments or reimbursements made to employees for country clubs.

Recipients of the letter included the Cleveland Clinic, New York Presbyterian Hospital System, and Fairview Health Systems in Minneapolis, which were given six weeks to comply.

The transformation of nonprofit health care demonstrates the larger forces facing nonprofits—overall revenue increases (from private and government payers) due to increased demand, causing charitable contributions to decrease as a percentage of total revenue, accompanied by waves of consolidation and system reforms to increase efficiency, accountability, and transparency. At the same time, total health spending in the U.S. rose far above inflation (strapping employers and individual payers), the uninsured population increased by 5 million to 35 million adults and 9 million children (from 2000 to 2003).

Problem-solving public officials looking for appropriate reform need to uncover the cause of the problem. Is the failure of nonprofit health institutions to provide adequate charity care a contributing factor to inequities in healthcare access? How much charity care should we expect nonprofit hospitals to provide, and from where do we believe this revenue will originate? Charitable donors wanting to offset high healthcare costs?

In 2004, giving to foundations was the fastest-growing category of contributions noted by Giving USA, reaching $24 billion or 9.7 percent of all contributions last year.1 The assets held by foundations grew by 9.5 percent to $476.7 billion in 2003, ending two consecutive years of decline, but remained below the peak level of $486.1 billion reached in 2000.2 The Foundation Center reports that the growth in contributions to foundations comes primarily from gifts greater than $5 million, which increased 18 percent to $17.9 billion in 2003.3

The number of foundations also continues to grow—reaching a record 66,398 in 2003, up 2.4 percent from 2002. Gifts made to foundations in 2003 grew to $24.9 billion—presumably contributing to the future growth of foundation payouts—a 12 percent gain over the previous year.4

The Foundation Center reports that in dollar figures foundation grant payouts have recovered from the effects of the 2001 stock market slide. Total grants reached an estimated $32.4 billion in 2004, up 7 percent from $30.3 billion in 2003. Despite small reductions in 2002 and 2003, foundation giving has more than doubled since 1997. But most of the $24 billion growth in foundation assets will be invested in stocks and bonds, and approximately 5 percent will be paid out in charitable contributions (less salaries and administrative expenses). As Mark Kramer observed in his 1999 Harvard Business Review article, “Philanthropy’s New Agenda: Creating Value,” there is a substantial cost to society of granting an immediate tax deduction up front but having the foundations hold most of the money aside.

Second only to religion in their share of 2004 charitable contributions, educational institutions (mostly colleges and universities) received $34 billion. They are increasingly channeling funds into endowments, held for future benefit and used as a hedge against hard economic times. The endowments of the 10 richest universities are now worth $78 billion—which the Institute for Jewish & Community Research in San Francisco points out is greater than the total GDP of the 75 poorest nations.

While it is true than anyone can be a contributor, and 80% of Americans contribute to something, we should be concerned that the stratification of wealth is also leading to the stratification of donors and the causes they choose to support.

The probes now aimed at hospitals, universities and foundations raises larger questions for the entire nonprofit sector: Does the net effect of nonprofit activity increase the equality of conditions for people in society? Shouldn’t it? Worse, do some nonprofits actually decrease the equality of conditions? Or do we think that, taken as a whole, the nonprofit sector has no overall impact on equity? Should we worry that the number and size of nonprofit organizations is increasing at the same time the distribution of income and assets is becoming more unequal?

Monitoring the near term conditions of the nonprofit economy is difficult at best, due to the lack of current economic performance information about the sector. Unlike most other industries or sectors of the economy (which know, for example, how last quarter’s same-store retail sales compared to the same quarter of the previous year), nonprofit and foundation boards and managers are making budgeting, hiring, and funding decisions not knowing what is occurring in their own field (until two years later, since they have to wait for the slowly filed, slowly aggregated year-end IRS 990 figures).

As a result, it is possible to hear wildly contradictory statements about the current situation. Boom? Bust? None of the above? On the one hand:

IRS Form 990 filings indicate that the nonprofit economy continues to grow faster than the economy as a whole, whether measured by jobs, total financial activity, or increase in the number of enterprises.5

And at the same time:

Budgets show further stress from domestic federal and state budget retrenchment, exploding employee health insurance costs, a 40 to 50 percent reduction in vehicle donations due to 2005 tax law changes, and increased costs from severe competition for charitable funds.

Like farmers who rarely admit to having a good year (not wanting to tempt the fates or incur the jealousy of their neighbors), nonprofits have a natural tendency to publicly discuss their difficulties—“things have never been so tight”—instead of their financial success.

While the official dates of the recent recession (which met the common definition of two or more quarters of a shrinking economy) were March through November 2001, for nonprofits and foundations the consequences of the economic downturn lasted well into 2003.

Nevertheless, looking at public charities divided into eight size categories based on revenues, the total revenues and the sheer number of organizations continued to grow throughout the period from 1999 to 2003. The across-the-board growth in the number of organizations has been cited by the Senate Finance Committee, and the Panel on the Nonprofit Sector, as one of the reasons for increased resources for state charitable law enforcement and the IRS.

Notwithstanding the increased number of organizations, the average amount of funds for each organization continues to rise (though, of course, individual results will vary). Every nonprofit size category saw real income growth from 1999 to 2003, with the greatest growth of the largest group, primarily universities and health care institutions, with over $100 million in revenues.

Each of the major nonprofit revenue sources is growing.

Charitable giving increased by 5 percent in 2004 to nearly $250 billion, according to the annual Giving USA report issued by the Giving USA Foundation6 Adjusted for inflation, 2004 giving rose by 2.3 percent—the first positive growth seen in inflation-adjusted terms since 2000. All of the major sources of charitable contributions are increasing—individual donations from living donors, bequests from dead donors, corporate giving programs, and private and community foundations.

Within the larger numbers, the aggregated totals and averages can hide a lot. It is difficult to tell what is happening to typical organizations. What percentage of organizations experienced budget growth during the last five years? To get an idea of what is actually happening to nonprofits would require a longitudinal panel study—tracking a national sample of organizations over time.

Unfortunately, that has not been done (though this could be a valuable contribution). Several factors suggest that the large dollar totals overstate actual nonprofit revenue growth, or the actual change in current beneficial activity delivered to the public by the nonprofit and philanthropic sectors:

With the end of the recession, most state government receipts are recovering—an important nonprofit source of revenue for arts and health and human services organizations. Since the late 1970s, some 29 states have adopted some limit on revenue, spending, or both. Forty-nine out of 50 states faced deficits in 2002, when state budgets were constrained by tax reductions adopted during the temporary budget surpluses of 1999 and 2000, leaving ongoing structural deficits. According to OMBWatch, 11 states are close to passing bills restricting spending or the use of revenue.7 Political pressure on legislatures has continued to limit revenue increasing options, though the national anti-tax movement coordinated by Grover Norquist of Americans for Tax Reform is showing early signs of having played out its message. (See the related article on state taxes by Karen Kraut on page 70).

A much heralded weapon in the anti-tax crusade, the state-level “Taxpayer’s Bill of Rights” (TABOR) is under fire in Colorado—the only state to have adopted it—now including pressure for change from Colorado’s Republican governor Bill Owens. Colorado voters passed TABOR in 1992 as an amendment to the state constitution, requiring that state revenues grow no faster than inflation and population increases—unwittingly creating a one-way “recession ratchet” with drastic cutbacks during an economic downturn, and little ability to replenish budgets when the economy recovers.

Governor Owens once appeared on the cover of the conservative journal National Review as “the best governor in America,” but is now leading the campaign to pass the “Colorado Economic Recovery Act,” to allow Colorado state government to modify TABOR to lift state spending limits for five years to provide additional revenues for education, highways, and public services. Grover Norquist called Owens a traitor for betraying taxpayers, and had similar criticism for Republican governors in Ohio, Connecticut, Alabama, and Minnesota for supporting tax increases.

If responsible community leaders including, business leaders, nonprofits, foundations, and some key Republicans go public with the positive aspects of government spending the worst instincts of the anti-tax forces can be thwarted. The Colorado Association of Nonprofit Organizations (CANPO), which helped defeat a ballot initiative in 1996 that would have eliminated the charitable property tax exemption, is currently leading a nonprofit campaign to persuade Colorado voters to support the initiative for the TABOR reprieve.

While state budget stress lessened somewhat, pressures from healthcare inflation (for state employees as well as the state share for Medicaid recipients), federal tax changes, and past tax cuts are forcing tough choices at the state level.

Congress has been wrestling with budget issues ever since President Bush submitted the administration’s 2006 fiscal year plan in February. The Republican-controlled House and Senate are attempting to reach agreement to somehow simultaneously make permanent recently adopted tax cuts, maintain ongoing federal commitments, and pay for Homeland Security and the Iraq war. The balanced budget is out the window (and the surplus of 1999 a distant memory), with a 2006 best-case deficit projection of over $420 billion. Both the president’s budget and the congressional budget resolution adopted in April place the greatest reductions in domestic human services programs and are having a hard time mustering public support. The budget resolution also required reconciliation legislation—which told committees how much they needed to cut.

Nonprofits have a variety of interests in this process—as direct recipients of federal dollars, as indirect recipients of federal dollars through state budgets, and also as advocates for people directly affected by budget items. Two areas of particular pressure are Medicaid and the Food Stamp Program, and seeing how these two matters are decided in the increasingly polarized U.S. political climate can help illustrate the opportunity nonprofits have to meaningfully weigh in.

As part of the fiscal year 2006 budget resolution approved by Congress in April, lawmakers directed the House and Senate to eliminate $10 billion in federal spending over five years from Medicaid. How will the Medicaid program implement $10 billion in cuts? The basic options are to shift expenses through block grants to the states, reduce eligibility, cap the number of participants, or capture greater efficiencies through various performance or contract reforms.

In April, Sen. Gordon Smith (R-Ore) spearheaded a proposal to form a commission to study Medicaid before making any program funding cuts. Health and Human Services Secretary Mike Leavitt in May established a commission to develop recommendations to HHS on methods to reduce Medicaid spending, but Democratic members of Congress rejected participation in the commission after Leavitt announced that he would appoint the 15 voting members, while eight members of Congress and several state Medicaid directors will have nonvoting advisory positions. The National Governors’ Association also declined to participate in the commission, as has Senator Smith.

The National Governors’ Association is concerned that the costs of Medicaid reductions will eventually be borne by the states, and some states (notably Missouri and Mississippi) have already drastically reduced Medicaid eligibility. The opportunity for non-partisan decision-making on changes to Medicaid, with community input on the effects of various options, is remote in the current environment—with a similar climate in other budget areas.

The larger destiny for the nonprofit economy is continued growth. The world needs and wants more of what nonprofits do, so their information, services, and quality of life activities will continue to capture an increasing share of U.S. income.

The national consensus not to add substantial numbers of government employees, combined with frequent use of nonprofits as a means to deliver government-funded services, has propelled much of this growth. However, pressure on state and federal budgets—fueled by debt and tax cuts over the last four years—has decreased the reliability and increased the frustration across the board for government-funded services.

As nonprofit managers and boards make decisions about where to invest their energy in the raising of resources, earned revenue and individual contributions look at first blush more attractive, palatable, and sustainable in the long term than government contracts and foundation grants. They also provide fewer constraints in terms of generating restricted dollars.

Foundation grantmakers have leapt onto the trend toward earned revenue. In years gone by, foundations were willing to be seen as the venture capital that demonstrated the benefit of new services, which could later be underwritten by government. Now that the probability of government picking up a foundation-funded pilot is ever more unlikely, foundations are more likely to reward nonprofits for proposing streams of earned income as the preferred sustainability strategy for special projects.

Supported by creative thinking, consultants and new organizations, the sector formed to confront market failure is now turning full circle to use the market as a solution to its own funding problems (in turn prompting the Grassley-style questions from many quarters).  In the promotion of earned income and blurring between the commercial and nonprofit sectors, grey areas opened up where social entrepreneurs but also tax scams and schemes abound. These have, in fact, been a good portion of what attracted regulatory scrutiny by the IRS and Congress.

Also grating on the sensibilities of public officials are the growing endowments of large nonprofit institutions where the public is experiencing increasing problems of affordability. A society with increasing inequality and increasing nonprofit and philanthropic activity should be an oxymoron, but it’s not, and that may prove to be its ultimate vulnerability. Foundations, hospitals, and universities are of special interest to lawmakers right now, with larger questions of what really should qualify for tax exemption waiting in the wings.

In short, behind the gross increase in nonprofit organizations and revenue is a substantial mirroring of the larger wealth distribution dynamics of the economy—the rich institutions are getting richer and generally only putting what they have to toward public benefit, and the small and mid-sized are running faster and working harder to maintain their place.

The asset growth by the largest institutions is seen as another indicator of the widening wealth gap in society, not a correction to it.  For a section of the economy that represents 8% of GDP, nonprofits can’t counter all the negative effects of a market economy, but they certainly shouldn’t be adding to them.

  1. Giving USA 2005 Press release. Giving USA, a publication of Giving USA Foundation, researched and written by the Center on Philanthropy at Indiana University.
  2. Foundation Center, Highlights of the Foundation Center’s Yearbook [PDF].
  3. Ibid.
  4. Ibid.
  5. We would like to thank Linda Lampkin and Kendall Golladay at the Nonprofit Center on Charitable Statistics at the Urban Institute for their help in generating statistics for use in this article. Nonprofits can perform their own analyses via the Web at:
  6. Giving USA 2005 Press release. Giving USA, a publication of Giving USA Foundation, researched and written by the Center on Philanthropy at Indiana University.
  7. OMBWatch Update May 16, 2005. The update mentions Arizona, Idaho, Kansas, Michigan, Missouri, Nevada, New Mexico, Ohio, Oklahoma, Oregon, and Wisconsin.