By Paul Levy

An excellent article by Stephanie Strom in Monday’s New York Times covers what appears to be a growing controversy about the degree to which nonprofit organizations should or should not be permitted to be tax exempt under federal and state rules. This is a legitimate area for public debate, and the article sets out a number of examples and points of view.

I do not know much of the history of tax-exempt status, but I am guessing it was given by Congress and state legislatures to certain categories of non-profits in light of their public service obligations and activities. I am personally involved on the boards of several tax-exempt nonprofits, including BIDMC, an academic medical center devoted to clinical care, research, education, and community service, MIT, a university, and others currently and previously.

Now, if we think about it, any one of these lines of service could be
provided by for-profit corporations. What does society
get out of granting tax-exempt status to these institutions? The most
obvious thing is that none of the gains (i.e., "profits") of
non-profits are distributed to private investors. They are all recycled
into the mission and services of the organization.

Society also gets these services delivered at lower cost. Why? Because
the nonprofits do not have to pay property tax, sales tax, or income
tax and because they can finance their capital needs using tax-exempt
debt instead of a higher cost mixture of equity (i.e., stock) and tax
debt. Also, they are more likely to receive philanthropic donations to
help pay for the services offered.

Thus, the underlying cost structure
of nonprofits to end-users and/or society, everything else being
equal, should be lower. (I say should be lower because some people have
argued that nonprofits are less businesslike and less efficient that
for-profit firms in the same lines of business and therefore actually
deliver services at a higher cost. Truthfully, I haven’t seen much
evidence of that, but that is not my argument for today.)

So, here’s the big policy question. What would people hope to achieve
by actually taking away the tax-exempt status of current nonprofits?
Putting aside the self-interest of people in for-profits who are in
competition with nonprofits, this desired outcome has to be driven by
the conclusion that society would be better overall by having certain
services provided only by taxable organizations, whether nonprofit or
for-profit. In essence, the goal would mainly be an attempt to create
tax revenues at the federal, state, or local level.

But, I think the actual question is more interesting and subtle: What
do people hope to achieve by threatening to take away the tax-exempt
status of current non-profits? If their goal is not actually to take
away the tax exemption, then they are seeking to have these
organizations do more of what they feel is appropriate in the way of
public service. (I set aside, for today, other purposes for such
activity that are designed to achieve results altogether different.)

Currently, the determination of whether an organization deserves
tax-exemption is left to the IRS and states’ Attorneys Generals or tax
departments. (The Minnesota court case cited in the Times article
represents what I believe to be an unusual judicial foray into this
determination, but I might be wrong on that front.) The IRS and the
others use broad categories of eligibility, as directed by their
respective legislatures. When questions are raised, these governmental
bodies have the authority to examine programs and records and take away
an organization’s tax-exempt status.

So, the question I pose for you is this. Are you content with the
existing form of rules and regulations covering the applicability of
tax-exempt status to non-profits? Does your answer depend on whether
you are talking about hospitals, schools, social service agencies,
athletic organizations, research institutes, or other categories?
(Let’s leave religious institutions out of the discussion for today!)
If you want changes, what are you hoping would be accomplished? How
would you measure success?