The International Journal
of Not-for-Profit Law

Volume 8, Issue 1, November 2005

By Pablo Eisenberg1

The nonprofit sector has experienced rapid changes in its composition, size, values, nature, and finances over the past few years. This transformation can be expected to accelerate in the next two or three decades. Yet its practitioners and researchers have done little or nothing to anticipate and prepare for these developments. Instead of looking hard at the future, they have chosen to bury their heads in the sand, avoiding some of the tough analyses and choices they invariably will have to make to keep the sector healthy and worthy of the public trust.

Not since the Commission on Private Philanthropy and Public Needs issued its report in 1976 has the sector collectively attempted to assess its current status – including both its achievements and problems – and to recommend changes in policies and practices. Organizations like Independent Sector, a coalition of some 600 national nonprofit groups and donor institutions, and the Council on Foundations, which represents 2,000 grant makers, were established to serve and protect the interests of their members, but they have failed to exercise their responsibility to look at the future.

Academics and researchers in the nonprofit field have reinforced this tendency by avoiding the toughest and most controversial issues – the ones whose implications and consequences will be most important to nonprofits in the future. They have paid a great deal of attention, for example, to such issues as voluntary action and volunteers, the history of foundations and nonprofit organizations, and management practices, and, most recently, they have been studying efforts to build the management capacity of nonprofit groups. They are paying very little attention to such matters as the governance of major institutions, excessive compensation of nonprofit officers and executives, sweetheart deals that provide financial benefits to nonprofit officials, and conflict of interest problems. Nor are they doing much to deal with the lack of public accountability by nonprofit organizations, government oversight, nonprofit advocacy, ties between universities and corporate America, the effect on nonprofits of the sector’s rapidly growing commercialization, and the impact of privatization on government-financed programs.

While it may be difficult to attract money to conduct research on these issues because of the reluctance of donors to sponsor “risky” topics, they are, nevertheless, the burning issues that are key to the nonprofit sector’s future. Our research community will be doing an enormous disservice to all of us if it continues to avoid these issues by seeking shelter in safe projects. Through a more germane and gutsy research agenda, it could provide us with a useful road map for productive change.

Public Accountability

What are the major areas of concern with which the nonprofit community must begin to grapple? The most important by far is the pressing need for transparency and public accountability. Foundations, which to date have been relatively unaccountable, depend on enormous tax benefits for their donors and for their operations. Ultimately, they answer to the elected politicians who represent American taxpayers. Nonprofit organizations depend entirely on charitable contributions, which, in turn, are based on one and only one factor: the public trust. Without it, nonprofit organizations cannot raise money and, therefore, cannot exist. Both sets of institutions ultimately depend on public esteem and support for their existence.

During the past couple of years the public trust in the nation’s nonprofit groups has been shaken by a series of scandals, excessive compensation, shoddy practices, corruption, ethical lapses, and poor board oversight. While our nonprofit apologists argue that the problem lies with just a few bad apples in the barrel, the prevalence of such behavior is far more widespread than we believed several years ago. There are many bad apples in the nonprofit barrel.

A Georgetown Public Policy Institute study of foundation trustee fees issued in September 2003 – of which I was an author – revealed that a high percentage of the foundations in its sample gave their individual trustees compensation, many well in excess of $25,000. In 1998 the 238 foundations in the study actually paid their trustees $33 million for their charitable activities, money that might otherwise have gone to financially strapped nonprofits. These payments contrast sharply with the policies of nonprofit organizations that do not pay any fees to their board members. The study also found that neither the Internal Revenue Service nor the state attorneys general had the resources, staff, or political will to oversee and police the foundation community.

These findings have been echoed by the growing revelations of foundation abuses in newspapers across the country. Not only have the media detailed the huge amounts paid in trustee fees at many foundations, but they have also spotlighted self-dealing activities, conflicts of interest, falsification of information on IRS reporting forms, a lack of transparency, and the absence of any federal and state oversight.

Such problems are not confined to foundations. They are prevalent among nonprofit organizations as well. There are many nonprofits that pay excessive compensation to staff members; do not pay taxes on their earnings from businesses unrelated to their missions, as required by law; do not provide information about their operations or boards; engage in board activities that are self-dealing; and conduct questionable fund-raising practices.

What’s more, embezzlement is not infrequent. The most publicized cases are merely the tip of a much larger mass of charities. Harvard University’s Hauser Center for Nonprofit Organizations reported, in November 2003, that top charity executives in a selected 152 nonprofit organizations stole or misused at least $1.28 billion from 1995 to 2002. The report was careful to point out that its findings were not a comprehensive assessment of charities’ fraudulent activities.

As the news media pay increasing attention to the nonprofit sector, the list of suspect organizations is likely to grow, bringing with it a decline in public confidence in our charitable organizations.

The abuses in the sector are compounded by the lack of oversight and enforcement on the part of federal and state regulators, as well as by the absence of tougher regulations that could assure greater public accountability.

Congress must bear a great deal of responsibility for this abysmal situation. It has largely ignored the operations of the nonprofit sector, content to let its problems slide as long as public scandals are minimal. Lawmakers focused little attention on the needs of the IRS’s tax-exempt division and never imparted to the regulators a sense that oversight was an important public matter. Until Congress, the IRS, and state attorneys general get their act together, the news media will remain the only reliable accountability mechanism we have.

The substantial federal excise tax paid by private foundations on their net investment income has never been used for its intended purpose – the oversight and policing of the nonprofit sector. While some organizations like Independent Sector, the National Council of Nonprofit Associations (representing statewide coalitions of nonprofit groups), and the Council on Foundations have gone on record supporting congressional action to target at least a portion of the excise tax for oversight, they have spent little or no time, energy, and resources to lobby for legislation that would give the IRS and state regulators the resources they urgently need. Had the large foundations and the Council on Foundations spent one-fifth of the time and money for this purpose that they expended in their recent efforts to kill the congressional measure to eliminate administrative costs from the calculation of foundations’ minimal payout requirements, at least a portion of the excise tax might have been channeled to oversight activities.

If the nonprofit world is to prosper and better serve civil society, it will have to deal with the problems of transparency and public accountability. Jealous of their independence and fearful of government intrusion, nonprofit executives for years have claimed that self-reform is the path to sectoral sanctity. Their rhetoric is strong and, sometimes, convincing, but their efforts have been minimal and unproductive. The truth is that self-reform rarely works, not at the New York Stock Exchange or among other nonprofits.

The reports filed annually with the IRS by both nonprofits and foundations currently are not an adequate mechanism for assuring transparency and public accountability. These reports need to be strengthened by requiring more data about self-dealing, conflicts of interest, excessive compensation, and trustee activities.

For example, the 990-PF forms that foundations are required to submit annually to the IRS do not ask specifically for the amount of time spent on foundation work by trustees; for a breakdown of allowances and other expenses, including travel, received by trustees; or for the relationship of trustees to contractors and service providers. The anti-self-dealing provisions in the regulations provide a huge loophole that has been exploited by foundations. They permit trustees and foundation managers to receive payment for services to their foundations that are “reasonable and necessary to carrying out the exempt purpose of the trust . . . and . . . not excessive.” As the Georgetown Public Institute study observed, “Because the standards are so unclear, the judgment of what is reasonable, necessary, and not excessive has essentially been left to the foundations themselves.”

Requiring nonprofit groups of a certain size to provide annual or biennial program and financial reports could supply additional information, so that the public can better evaluate nonprofit performance of at least the larger organizations. Small organizations often can’t afford to spend the time and money on extra paperwork, nor can government regulators keep up with all the nonprofit groups that exist – so focusing on the largest ones makes most sense. In addition, federal regulations governing self-dealing, compensation, and ethical behavior need tightening.

While more effective regulations and clearer criteria for evaluating nonprofit abuses are urgently needed, a major defect of the oversight system now in place continues to be the lackadaisical enforcement measures by both federal and state regulators. The number of audits of nonprofits conducted by the IRS remains minimal. Slightly more than 1 percent of groups are audited, as the IRS has done little to increase the number of staff members who monitor charities, even though the number of charities more than doubled in the past decade. The criteria by which the IRS assesses excessive compensation often appear to be driven by corporate standards. And only a minuscule number of nonprofits have been fined or punished by the agency for excessive-benefits transactions. Several states don’t even have a tax-exempt unit in the attorney general’s office; with few exceptions the offices of the attorneys general have neither the resources nor the interest to pursue charity abuses.

Whether the IRS is the proper agency to oversee the nonprofit sector or should be replaced by a new quasi-public entity like Britain’s Charity Commission for England and Wales, which acts as application clearinghouse, adviser, and investigator, has been a subject of discussion among researchers. Such an agency could oversee charity officials, in much the way securities dealers here are regulated by quasi-governmental agencies under the supervision of the Securities and Exchange Commission. While the IRS needs restructuring, I think it would be unwise to delegate responsibility for oversight to anything but a government entity that has a vested interest in ensuring that tax-subsidized nonprofit groups are working in the public interest.

Public or Private?

Recent congressional efforts to increase the amount of money private foundations are required to distribute each year triggered an energetic public debate, the first time in decades that such a discussion extended beyond closed-door conversations between foundations and legislators.

Gone are the days when matters concerning philanthropy or nonprofits could easily be hidden in the shadows. That is one of the major reasons foundations were so disturbed by the efforts of some nonprofits and lawmakers to bring the payout issue into the open. It also explains the anxieties of some nonprofits about divulging the names of their supporters. Transparency is the cornerstone of accountability; it is a trait that Congress must require of all tax-exempt organizations.

Foundation assets are not the only endowments that require further inspection. Donor-advised funds, which operate like charity checking accounts, should be subject to a minimum payout requirement. Now donors can keep putting money away in donor-advised funds year after year, claim their tax deduction, and never give away a cent until they die.

Nor are universities or other nonprofit groups that have endowments required to distribute any of their assets. Should these institutions be permitted to accumulate vast sums of money at taxpayer expense without distributing an adequate amount of money for charitable purposes, such as scholarships and programs to serve society? If not, what minimum percentage of their endowments should they distribute each year?

Are Too Many Organizations Given Tax-Exempt Status?

To many observers, the composition of the nonprofit sector doesn’t make much sense. It includes such disparate institutions as hospitals and universities, social service agencies, grassroots activist groups, cemeteries, trade associations, a few insurance companies, co-operatives, and fraternal organizations.

Should they all continue to be lumped into the category of tax-exempt groups governed by some of the same rules, or should the sector be more narrowly defined? Hospitals and higher-education institutions account for roughly two-thirds of the operating revenue of all organizations categorized as charities under the tax-exempt section of the Internal Revenue Code. Should such organizations be placed in a separate category of nonprofits? Why should the New York Stock Exchange have any type of tax-exempt status, since it serves profit-making entities on Wall Street and provides compensation to its executives that can only be described as excessive by nonprofit standards? Why are professional sports associations and corporate trade associations that lobby for profit-making corporate interests allowed to have tax-exempt status?

One of the distinguishing characteristics of nonprofit organizations is their mission of serving the public interest. Many would argue that some of the groups that have tax-exempt status do not meet that test.

Far more attention needs to be given to what types of organizations the IRS approves as charities. Under the current system, applications for tax-exempt status are almost automatically approved. The IRS simply doesn’t now have the resources to do a more thorough job of examination.

As one might suspect, a number of questionable organizations have slipped through this screening, including a number of charities that are at least as much political as charitable. One example is an organization called Celebrations for Children established by the House of Representative’s majority leader, Tom DeLay. Its purpose was to help throw parties and trips for legislators attending the 2004 Republican National Convention in New York. Though Mr. DeLay claims some of the money the charity raises will be spent for needy children, the primary purpose of the organization is political. In short, it is a sham nonprofit that doesn’t deserve charity status. Other highly political organizations have been approved as charities in the past. The sector needs to assess this practice and take measures to stop it.

Growing Commerciality

Under pressure from declining public revenues and increased competition for scarce philanthropic dollars, a large number of charities are charging fees for services and starting profit-making enterprises. The growing privatization of publicly financed social programs, formerly the almost exclusive dominion of nonprofits, has pushed charities to become more corporate in nature to remain competitive. The line between what is nonprofit and for-profit has become even more fuzzy than it was.

The corporatization of a large number of nonprofit organizations has opened institutions to questionable practices: an undermining of standards and ethical practices; an increasing focus on the bottom line; the weakening of organizational mission; special attention to the CEOs, with their high salaries and special perks; and an aversion to policy activism and risk-taking. Many nonprofits are in danger of losing what Paul Light of the Brookings Institution has called their “nonprofitness.”

For many years the IRS has required nonprofit organizations to pay taxes on their for-profit enterprises that are deemed to be not “business-related” – that is, not intrinsic or connected to their charitable missions. But the criteria by which the agency decides what is or is not related remain vague and uncertain, an imprecise guideline for nonprofits to follow. Many nonprofit-run businesses can be called “related” only by the stretch of one’s imagination. The Metropolitan Museum, for example, sells items found in its museum shop in New York in a number of shopping centers outside the city and does not pay taxes on a share of the money made in those stores. That ruse enables many charities to avoid paying taxes that they should have to pay as part of their responsibility to be good citizens. As public funds diminish and charities desperately seek new sources of support, they will increasingly turn to the creation of new business ventures as a way out of their financial crises. All the more reason that the IRS, with assistance from the nonprofit sector, must more clearly define the line between what is and is not “business-related.”

Neither the regulators nor the nonprofit community can afford to postpone facing and resolving this issue. It has festered for too long a time. Until clarity is provided, many individual and institutional donors will hesitate to give their money to nonprofit organizations that look as though they have become more a business than a charity.

Charities increasingly seem to be lowering their ethical standards as part of their fund-raising strategies. Local Boys and Girls Clubs, for instance, put soda machines in their buildings in exchange for a huge donation to the Boys & Girls Clubs of America by Coca-Cola. Money appears to have trumped a concern for the health of the children who attend the clubs. Similarly, the selling of billboards at university stadiums to companies willing to pony up large contributions, or deals between sports equipment firms and university basketball or football officials, send a message that institutions of higher learning can be bought by whoever is willing to pay the price.

The selling of nonprofit America is a trend that endangers the sector’s “nonprofitness.” Can we prevent the further erosion of nonprofit values? How? It is a matter that doesn’t lend itself easily, or at all, to government regulation and oversight.

But here, surely, is an issue that can test the sector’s desire for self-reform. Will the chancellors and presidents of our universities and colleges be willing collectively to stop the selling of their institutions to corporate and other financial interests? Will nonprofit organizations voluntarily adopt a code of ethics and conduct that will give top priority to organizational mission instead of fundraising at any cost? Will the major nonprofit associations be willing to organize a mass effort to promote and enforce among their members higher standards of conduct and ethical behavior? And will foundations, much in need of reform themselves, support such efforts financially?

And what about the problems of unethical behavior and conflicts of interest in the nonprofit world? For example: board members who have close ties, financial and family, to companies that provide services to their organizations; highly paid staff members of nonprofits who moonlight for other organizations; and the selling of mailing lists to commercial enterprises. Can we do something about these disturbing practices?

Clearly, some large nonprofit organizations like AARP can have an inherent conflict of interest between the services they sell to their members, the public-policy positions they take, and the profit-making enterprises they operate. A growing number of universities are accepting substantial corporate donations in exchange for corporate influence on their faculties and research efforts, including, in some instances, the right to review research findings before publication. Where do you draw the line? What is an acceptable balance between an organization’s mission and its business interests?

The answers to these questions will determine the extent to which the nonprofit sector is capable, in John Gardner’s words, of renewing itself.

Promoting Democracy

An even greater challenge to our nonprofit institutions will be their collective ability to promote and strengthen democratic institutions and practices.

From its earliest days, a primary mission of the nonprofit sector has been the preservation and strengthening of American democracy. This role has taken many forms: protecting civil liberties and individual rights; leveling the playing field for all citizens; building strong democratic institutions; providing a social safety net for the neediest members of society; and assuring a competitive free-enterprise system. Writing in the 1830s, the astute French observer of American society, Alexis de Tocqueville, noted that voluntary associations were at the heart of American democracy. Were he writing today, would he give such high marks to our voluntary sector as an effective promoter of American democracy?

The inequities in wealth and income have grown exponentially over the past two decades. The rich are richer and the poor are poorer than ever before in our history. The differential in pay between top executives of American corporations and the average worker in these corporations rose from a ratio of 72:1 in 1989 to 310:1 in 2000. The social safety net has been shredded if not entirely destroyed by our lawmakers. The minimum wage adjusted for inflation is lower today than it was 25 years ago. For many Americans – the poor, people of color, the disabled, and other disadvantaged populations – the playing field is not level.

The enormous expansion of foundation assets in recent years has added to the inequities in American life. As public support for social programs, job training, affordable housing, and projects to feed the poor and temporarily house the homeless have been reduced, the burden for such responsibilities has increasingly fallen on private individual and institutional philanthropy. Public responsibilities are becoming a matter of private charity. An elite, growing, and unrepresentative group of private foundations are now making decisions about the allocation of funds for social welfare. In a sense, “noblesse oblige” is slowly taking over what should be public decision-making.

Far from leveling the playing field, civil society appears to have acquiesced or, at worst, abetted a national policy that has slowly made it more difficult for many citizens to enjoy equal opportunities and, at the same time, made it easier for wealthy citizens to assert greater control over society. Nowhere is this more evident than in the enormous abuse of power and influence that corporate America has exercised in recent years, both in the public and private sectors. Few checks and balances are in place to stem this corporate force. This was a role nonprofits were supposed to play, assisted by government and our political elites. What happened? Were nonprofits bought off, too weak and fragmented or without the leadership and financing to counter this development? Whatever the reason, it is imperative for the nonprofit sector to resume this role, to serve as a watchdog against further corporate abuses as well as government excesses.

Research, monitoring, and advocacy by citizen groups are the weapons that can provide the institutional balance between government, corporations, and civil society that is essential for democracy. Whether nonprofits will have the vision, resources, and courage to wage this important struggle will depend on two major factors: their acceptance – a departure for the large majority – of this role and a willingness to broaden their program agenda; and the willingness of foundations to end their reluctance to support the type of monitoring and advocacy that is needed to do the job.

Nonprofits have another major responsibility in assuring the vitality of our democracy: strengthening a political system that has become corrupted by big money, and rebuilding the credibility of government, especially the federal government, from which many citizens have become alienated. That is a tall order, but one for which the nonprofit sector is well suited. Its hundreds of thousands of organizations have the capacity to support and sustain campaign-finance reform measures; to promote greater civic engagement, especially by our young people; to encourage greater voter turnout through voter registration and education initiatives; to make certain that our schools teach American history and citizenship; and to make certain that their own organizations remain democratic, reaching out to those they represent so that their members may become more involved in organizational governance and programs.

Making Nonprofit Groups More Democratic

That task, what may be called the democratic renewal of nonprofit organizations, probably poses the most difficult challenge. During the past 25 years, the large national nonprofit organizations have lost much of their former membership. In a number of cases, their chapters have lost influence; new large organizations have emerged without chapters.

Professional staff members and lobbyists have assumed responsibilities once exercised by members. Many people have become less engaged in community affairs. For so many, civic engagement now means writing a membership check. Many nonprofits have thus lost their real base in the community. Do they continue to speak for the people, for the community? If they want to be a greater force for influence and change, nonprofits need to reengage with their members, their constituents, and their communities. In a real sense, they have to become more democratic.

Who speaks for nonprofits? Large organizations, some actually trade associations, have been established to be a voice for their nonprofit members. Independent Sector purports to represent the views of nonprofits on sector-wide issues. Similarly, the Council on Foundations attempts to reflect the interests and opinions of the foundation world. And the National Council of Nonprofit Associations is a voice for the 40 or so state associations of nonprofits. But do they and the other significant associations really reflect the views of the sector as a whole?

Independent Sector, for example, does not have any local or state members. A substantial portion of its membership comes from foundations that represent only a tiny sliver of the nonprofit world. The nonprofit organizational members represent the most established, large nonprofits in the country; this membership doesn’t include many organizations that reflect the interests of activists, women, union members, youths, or low-income people. It is, in short, not a diverse group. While it has been a force for good on several national issues, its influence will be limited until it reaches out to encompass more diverse organizations and listens more carefully to what the field is saying. As long as such a large number of its members are foundations, the organization will find it difficult if not impossible to steer an independent course on philanthropic issues. Its missteps have come from too great a dependence on a small coterie of board members.

In protecting and promoting our democracy, civil society must be careful to assure that its own nonprofit institutions govern and act democratically. Many nonprofits and their umbrella organizations have not had the time or inclination to join together in an effort to study their sector, analyze its problems, and suggest ways to strengthen and improve its work.

It is time for a national commission – like the Commission on Private Philanthropy and Public Needs, headed by John Filer – to undertake this task and look seriously at the future. Composed of representatives from a cross-section of society, supported by an outstanding staff of researchers, policy analysts, and practitioners, this commission could not only provide useful data but also suggest a blueprint for civil society’s renewal and change. For several million dollars a year over a two- or three-year period, it could be one of the best investments ever made by our foundation community. There is nothing to lose and much to gain by such an effort.

A Sense of Perspective

In building for the future, finally, nonprofit practitioners must try to regain their sense of humor. Not too long ago, it was impossible to attend a conference of nonprofits or philanthropists without hearing jokes and funny stories from featured speakers and other presenters. Laughter was an important ingredient of our work then, balancing our hard, sometimes frustrating efforts with a light touch that reminded us not to take ourselves too seriously.

Today, there is little humor in our conferences or among our personal interactions. We seem often to be driven by a puritanical streak that seals off our lighter side. Aren’t we, after all, doing good in the public interest, the Lord’s work as it were, plugging the dikes that protect our society? Is it such serious business that there is no place for laughter? Is it surprising, therefore, that some view us as self-righteous prigs, cocooned in our little solipsistic world? There is, unfortunately, a good deal of truth in this observation.

Sometimes we tend to forget that fun is part of our job. We need to enjoy our organizational responsibilities, our colleagues, our competitors, our opponents, and our benefits as nonprofit workers. We need to take our challenges, successes, and mistakes in stride. We have to understand the tensions and ironies that undergird our activities with a willingness to laugh at ourselves, not only at others. Joy and laughter – those are the elements that can provide a wholesome balance to dedication, zeal, hard work, and perseverance. A healthy sense of humor is the link that connects both sets of ingredients. It is what the nonprofit world desperately needs as it struggles to meet the challenges of the future.

Notes

1 Pablo Eisenberg is a senior fellow at the Georgetown University Public Policy Institute and the author of Challenges for Nonprofits and Philanthropy: The Courage to Change (Tufts University Press/University Press of New England). He has been leader of the Center for Community Change, one of the nation’s most highly regarded poverty-fighting organizations, and founded the National Committee for Responsive Philanthropy, of which he is chairman emeritus. For the past decade he has been a regular columnist for The Chronicle of Philanthropy. Excerpt from Challenges for Nonprofits and Philanthropy: The Courage to Change, by Pablo Eisenberg, edited by Stacy Palmer. Copyright 2005 by the Trustees of Tufts University. Used with permission from University Press of New England, www.upne.com.