Category: Taxes

Abuses of US Non-Profit Status

The holiday season is typically when US charities collect the majority of their donations. Let me start by noting that the US non-profit sector is vibrant, generating positive outcomes across many aspects of society. But there’s an unfortunate dark side, and a degree of abuse of the system that is appalling. When organizations with CEOs making $10M+ per year spend little on charitable services and pretend to be non-profits, that’s appalling. When organizations that are blatantly political in nature raise limitless funds and pay no taxes, that’s appalling. When some of the largest hedge funds in the land pretend to be “universities” while raking in billions, that’s appalling – and the list goes on.

I have given to charities for many years, but with the start of our family foundation, I’m now formally involved in the sector, making choices about grantees. The process of grant-making has enabled me to refine my thinking on the kinds of impacts we’d like to see, and on how to measure and quantify our impact. But seeing a range of pitches and organizations also helps me to see and understand what I don’t support – this rant could run a mile, but here are the quick hits, the sorts of organizations that I believe fundamentally abuse the tax code:

Non-Profit US Hospitals: The majority of US hospitals are organized as non-profits, and yet non-profit hospitals spend only 2.3% on charity care, which is actually less than for-profit hospitals! Non-profit hospital chain CEOs have compensation similar to Fortune 500 CEOs, and don’t do much charity work, so why don’t we end the sham and strip their status? Senator Chuck Grassley has been a lonely voice of reason on this issue for years. Ask yourself – why is it that doctors, pharmacies, medical labs, pharma companies all pay taxes – so why do hospitals get a special free pass?

And what’s more evil than pretending to be a non-profit while bankrupting patients by the thousands? Doing it while using sick kids as a way to tug at heart strings. Unfortunately most children’s hospitals also provide very little charitable care, and also pursue patients into bankruptcy just like any for-profit company.

501 (c) (4) organizations: These organizations were original meant to be “social welfare” organizations, but have now devolved into another form of super-pac which lobby and influence politics via donated funds! But why aren’t they taxed on “profits” like any other corporation? Both parties have used and abused these structures to the max now – pray for us poor souls in Georgia who have been pummeled non-stop by Walker and Warnock ads for months. Here’s an idea: instead of spending $500M on ads, you are raising enough money to actually impact the issues you claim to care about? You could literally buy school supplies for every teacher in Georgia, or pay for police officer training or equipment – whatever your issue, you could impact it with that kind of money, and prove your ideas to voters!

University Endowments: Elite universities have fallen into the same trap as hospitals, in that they no longer spend significant sums toward the public good, but hide behind non-profit status as their endowments grow ever larger. Harvard, Yale, Stanford and other universities with massive endowments spend less than 4.5% of their endowment annually, while generating investment returns of over 8.5% annually over the last decade. They grow the cash pile further by soliciting donations that they have no plans to spend! Is the primary purpose of a university to be a brand for endowment fund-raising?

Honorable Mention: Donor Advised Funds enable individuals to “donate” money to a “charity” and gain a tax deduction, but do not require that the funds ever be distributed! As a result, $142 Billion in donations sat in DAFs as of mid-2021, generating fees for investment managers while not being used for any further societal purpose.

What’s the solution here? Has the American non-profit system become so bloated that it needs to be torn down? A simple starting step might be to raise and enforce requirements around actual charitable work – if private foundations are required to distribute 5% to charities annually, surely operating charities can be required to spend 5% of their revenue on bonafide charity work annually?

P.S. I think there are a great many causes worth supporting out there in this giving season. GiveWell and the Copenhagen Consensus do a good job researching both charities and areas where donations can provide maximum benefit. And you can see my family foundation’s grantees here.

Posted on by praveenghanta 0

A Better Estate Tax Reform

Replacing the estate tax with fair (no step-up) capital gains taxation at death could raise revenue for tax reform, and get rid of complex tax avoidance schemes

Among the many changes proposed among the Trump and GOP tax plans is the end of the estate tax – long a cherished Republican goal. Today’s Republicans decry the estate tax as a form of double taxation, while proponents (including Republican President Teddy Roosevelt) view it as a means to prevent an aristocracy formed through inter-generational wealth transfer.

What’s overlooked in the estate tax debate is that there’s a simple solution at hand, if we just look north, to Canada. This may be surprising to many Americans, but in the early 1970s Canada repealed its estate tax, replacing it with a simple application of capital gains taxes.

Canada applies its capital gains tax to an estate by assuming that the assets have been sold on the date of the owner’s death. Instead of taxing an estate in a special way, a consistent application of the existing capital gains tax serves to eliminate loopholes (in particular by eliminating step-up basis) and raise revenue while also substantially lowering the top rate of tax on estates. If transfers of ownership are treated as taxable for capital gains purposes, this eliminates the use of trusts and step-up basis as a multi-generational tax avoidance scheme, since tax would be paid on any change of ownership, including when assets are transferred into the trust.

Instead of exempting substantially all estates (as with current law), a capital gains tax-based approach could simply apply current capital gains brackets. The top rate of 23.8% would represent a reduction of over 50% from current rates. This change could generate substantial revenue to enable other aspects of tax reform – in the year 2000, when the estate tax exemption was $1.3M for a couple, it generated $25B per year in revenue (after substantial exclusions, credits, and deductions). With the economy today 90% larger than in 2000, it’s likely that a similar tax would generate nearly $50B today. Elimination of step-up basis could double this figure by adding another $50B – and $100B per year would pay for a huge chunk of current Republican plans on business tax reform, without penalizing most individuals.

Unfortunately, Republicans are fixated on ending the “death” tax and ramming through their current plan, while Democrats are interested in keeping top estate tax rates in place – when a broader capital-gains based approach would be fairer and would generate more revenue. Hardly the last time a good moderate approach is left to die in our polarized political climate!

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A Better Capital Gains Tax

Taxes on long-term capital gains have fluctuated in recent years, with rates as low as 0% (for lower income groups) and as high as 28%. At the end of 2010 capital gains rates will likely revert to 20% after being at 15% for several years. While long-term term capital gains enjoy a tax break, short term capital gains (on positions held less than one year) have long been taxed at marginal income tax rates. While dividends have more recently been accorded the same tax breaks as capital gains, interest payments continue to be taxed as marginal income.

Capital gains tax breaks are designed to encourage investors to invest in the economy for the long term, thereby promoting economic growth. As currently structured, the capital gains tax break doesn’t really achieve this, as it simply rewards investors that hold a position for more than one year. The law does not distinguish between investments in startups or IPOs and in purchases of existing equity shares. With regard to real estate, the law encourages the tax-free flipping of properties via 1031 transactions, but does not reward investors who improve their properties.

Rather than subsidizing investments in existing shares and property, shouldn’t capital gains tax breaks attempt to promote new investments? This could be easily accomplished by lowering the capital gains tax rate to 0% for all new capital investments, irrespective of investment duration. A new capital investment could be defined as an investment in which the target company directly receives the proceeds of the investment. Investments in IPOs, secondary offerings, startup companies (including angels and VCs), and real property improvements would qualify, while purchasing of existing shares and real estate would not.

A 0% tax rate on new investments would incentivize real investment in the economy, rather than encouraging simple tax-related shuffling of existing investments. In order to offset deficit impacts, traditional capital gains tax breaks could be reduced or eliminated. Moving to a system in which new investment is incentivized would tip American finance away from the casino mentality of recent years, and back towards its original purpose: investing in promising companies for profit.

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