Nonprofit organizations occupy a special place in American life. They care for the sick, educate school children, maintain the social safety net, and strengthen communities. In return, federal, state, and local governments provide them with a range of tax benefits. TPC’s Adam Looney and his co-author Nathan Born estimate the federal income tax exemption alone was worth $21.2 billion in 2018.

But as the nonprofit sector has evolved, policymakers are asking harder questions about sector reform. What do those tax benefits aim to accomplish, and do current rules help achieve those goals?

A recent TPC event, “Trust, Tax Policy, and the Future of the Nonprofit Sector,” brought together researchers, practitioners, and policy experts to address those questions. The speakers differed on the answers but agreed on two priorities: preserving the independence and pluralism that distinguish American civil society and pursuing reforms that work in practice.

What is the nonprofit sector for? 

Michael E. Hartmann, coeditor of The Giving Review, opened the first panel with the foundational question. The answer matters because the sector occupies a special place in America’s social contract, and its special status depends in part on public trust.

Greg Berman, author of The Nonprofit Crisis, said that enduring institutions need to be willing to examine themselves and respond to legitimate criticism.  That includes taking concerns about the sector seriously even when criticism is perceived as unfair. 

Benjamin Soskis, senior research associate at the Urban Institute’s Center on Nonprofits and Philanthropy, framed the question in historical context, emphasizing the “alchemy of pluralism.” Allowing a wide variety of organizations to pursue different conceptions of the public good is itself part of what civil society contributes.

Scott Hodge, a tax and fiscal policy fellow at Arnold Ventures, focused on the increasingly blurry line between charitable and commercial activity. He estimates the sector generates $2.8 trillion in business-related revenues. Current unrelated business income tax rules, he asserted, have not adequately addressed that distinction. 

Dean Zerbe, national managing director at Alliant Group and a former senior Senate Finance Committee staff member, emphasized engagement. Rather than simply defending existing rules, he said, nonprofit organizations should work with policymakers, acknowledge legitimate concerns, and bring their own solutions to the table.

The panel did not recommend a single method of reform, nor could it have: The nonprofit sector ranges from major health systems and universities to local charities, religious institutions, and tiny volunteer groups. But they pointed to a useful question: Are tax rules producing the public benefits they were designed to encourage?

One nonprofit tax policy does not fit all

TPC’s Joseph Rosenberg, moderating the second panel, made the nonprofit sector’s heterogeneity explicit. Nonprofits differ dramatically, and so do their donors and sources of revenue. Policymakers therefore need to avoid painting the entire sector with a broad brush.

Research presented by Stephanie Karol, a financial economist in Treasury’s Office of Tax Analysis, illustrated the point. Her work using Schedule B of Form 990 shows a funding system more complicated than individuals simply writing checks directly to charities. Foundations, donor-advised funds, other nonprofits, and corporations also play important roles in moving resources through the sector.

University of Maryland PhD candidate Adam Tucker focused on giving by wealthy households. Tax policy, he noted, can affect not only how much people give but when they give, what assets they contribute, and which charitable vehicles receive those assets. Capital gains and basis rules can themselves become charitable-giving policy because they influence whether appreciated assets go to charity and when. Donors can receive tax benefits when assets are transferred to private foundations or donor-advised funds, even if operating charities receive money much later.

Elinor Ramey, partner and chair of the exempt organizations practice at Lowenstein Sandler LLP, identified a tradeoff: Encouraging faster distributions to operating charities can put more resources to work today but leave fewer charitable assets available for future needs. Policymakers therefore need to identify the goal before deciding that faster distribution is necessarily better.

What are taxpayers buying?

TPC Codirector Elena Patel focused the same question on nonprofit hospitals: What is the tax exemption actually buying?

Her research comparing nonprofit and for-profit hospitals finds that nonprofit hospitals provide somewhat more charity care, but they also hold more cash and invest more in buildings and administrative wages. That raises a governance question: Who monitors the use of resources in organizations that do not have shareholders with a financial claim on profits?

Patel also finds evidence that state oversight can matter. Nonprofit hospitals behave differently in states with stronger reporting requirements and greater attorney general authority over hospital transactions. That points to alternatives to the stark choice between preserving tax exemption unchanged and eliminating it. Policymakers could strengthen oversight or target subsidies more directly toward the public benefit they want to purchase.

Ramey added a broader caution about using the tax code to solve every problem involving nonprofit institutions. Churches, fee-for-service institutions, and endowment-based organizations have fundamentally different funding models and policy concerns, making uniform tax rules difficult to design. 

Difficult questions still point to possible solutions

Across both panels, participants identified a range of possibilities rather than one sweeping reform. Policymakers could revisit the treatment of commercial income, strengthen oversight of nonprofit institutions, reconsider payout incentives for foundations and donor-advised funds, examine the treatment of appreciated assets, improve data about the flow of charitable resources, or subsidize particular public benefits more directly. They could also ask, before changing the tax code, whether tax policy is the right tool for the problem at hand. 

The speakers identified tradeoffs, concrete tools available for reform, and needs for better evidence. The discussion also showed the value of bringing competing perspectives together to identify where the evidence is clear, where it is not, and what policymakers can do next.