Philanthropy is in need of a deep retrofit.

We are in an age of gilded giving. Small donor giving is in deep decline. Philanthropy is dominated by rich individuals and foundations, not because they’ve increased their giving as a percentage of their wealth, but rather because of the enormous rise in their wealth. We’re in the midst of a crisis where as many as 40% of all nonprofits could be out of business by the end of next year. Yet even now, during an unprecedented emergency, hundreds of billions are being warehoused in private foundations and donor-advised funds (DAFs), giving vehicles primary deployed by the richest 0.1%.

Into this moment, Boston College Law Professor Ray Madoff and billionaire philanthropist John Arnold—backed up by some big names in philanthropy and academia—launched the Initiative to Accelerate Charitable Giving (ACG) with great fanfare. The initiative calls for a series of tax policy reforms that aim to fix what’s broken in philanthropy. Unfortunately, the proposal doesn’t even get the sector out of park (as in, “park your wealth”), much less accelerate giving. Worse, it adds to the glossy veneer of billionaire generosity without fundamentally altering the power and prerogatives of the super-wealthy and their charitable giving.

(Editor’s note: Be sure to read Inside Philanthropy’s recent coverage of the Initiative to Accelerate Charitable Giving, in which Madoff unpacks the proposed reforms.)

Arnold accurately draws attention to the deep problems in current philanthropic policies: “The rules disincentivize philanthropists from giving with any sense of urgency… Foundations and donor-advised funds get immediate tax breaks, and feel no pressure to deliver resources to where they are needed: charities solving this generation’s most pressing problems.” Yet ACG’s proposals do little to change this.

Take private foundations. As wealth has concentrated over the last four decades, so has the growth of private foundations. There are over 115,000 private foundations holding $1.1 trillion in assets. Yet, according to Giving USA 2020, only about $66 billion of this largesse goes out the door to nonprofits each year under rules that require a mere 5% annual payout.

ACG’s proposed solution is a carrot with two options for foundations: It lowers the small annual excise tax for foundations—currently 1.39% of net investment income—if a foundation increases its payout to 7%; or it eliminates the excise tax if a newly created foundation agrees to limit its life span to 25 years.

There are several problems with this. One is the notion that this is actually an incentive. For example, co-author Alan Davis manages the Leonard and Sophie Davis Fund, which has an endowment of roughly $150 million, net investment income of $30 million over three years, and total excise taxes of $400,000 over that period. That averages just 0.1% of assets each year, fairly typical for foundations. Show us the accountant or trustee that would recommend increasing one’s payout by 2% or limiting the life of a foundation solely to save 0.1%! Assuming the Hewlett Foundation, an ACG supporter, has similar investment returns, will it pay out another $200 million each year in order to save $10 million in taxes?

Lawmakers have experimented with differential excise tax rates in the past to incentivize higher payouts; it hasn’t worked, which is why just last December, Congress eliminated the two-tier rate and set the current flat rate. Increasing the mandatory payout rate is the only real way to stop the present warehousing of charitable dollars in endowments that are managed to keep growing forever.

But the biggest problem is that foundations shouldn’t require any additional incentives to achieve a 7% payout. It’s akin to giving tax breaks to corporations for not breaking the law. This is exactly the distribution level that allows a foundation to exist in perpetuity, based on historical investment rates of return. At the very least, Congress should mandate the 7% payout so that nonprofits receive an additional $20 billion a year. We’d recommend even higher payout rates for foundations with more than $500 million in assets. Most immediately, Congress could rise to the urgency of this moment by mandating a 10% payout for three years, as we’ve recommended as part of the Emergency Charity Stimulus proposal.

The ACG includes some reforms to discourage private foundation abuses and increase accountability, the most significant being disallowance of foundation grants to DAFs from counting toward payout. This is one way to address the misuse of DAFs to game payout numbers. Also, salaries and travel expenses for family members would not count toward the payout requirement. But exorbitant salaries and posh vacation-like retreats shouldn’t count toward foundation payout whether they are for family members or non-family trustees, or for that matter, staff. But here’s a simpler proposal: Exclude all overhead from payout calculations entirely. This would provide a strong incentive to keep overhead costs down.

Donor-advised funds, while small compared to private foundations—with assets of roughly $120 billion—are the fastest-growing sector in philanthropy and the preferred vehicle for many newly minted billionaires. The core of the ACG proposal is giving DAF donors the choice of either limiting their DAFs to a 15-year lifespan and receiving their charitable income tax deduction up front, or, if they forego that 15-year limit, receiving their income tax deduction only when funds are distributed to charities out of their DAFs.

We agree with Arnold’s view that it makes no sense for donors to receive full tax breaks up front for gifts that may not reach charities for many, many years to come. It’s problematic enough for private foundations, and even more problematic for DAFs. Why? Because DAFs offer greater tax advantages than private foundations; have no payout requirements; and, under the (practical, if not legal) fiction that donors give up control of their funds to DAF sponsors, allow donors to skirt the reporting and transparency required of private foundations. Great for the donors, but how does this benefit grantees?

Why should nonprofits wait 15 years to receive money for which the donor has received an immediate tax benefit (which can be as high as 90% in high-tax states) and the taxpayer-supported DAF earns tax-free dollars over that period of time? There is a very simple solution to the DAF problem and getting money into the hands of nonprofits: Require a minimum 10% annual distribution.

ACG’s second option for DAFs is puzzling: What would motivate someone to fund a DAF and forego the income tax benefit? We can think of only one reason: to make a gift where the benefit of overstating the value of a donated complex asset outweighs the income tax benefit. As with ACG’s private foundation proposal, not even a rabbit would be enticed by these so-called carrots. Requiring a higher mandatory payout is the simple and effective solution.

We agree with the ACG proposal in that DAFs should use the cash value of a donation to determine the size of the donor’s income tax deduction. But in terms of addressing the excessive power of the wealthy, this has little impact compared to either limiting the charitable deduction to cost basis when giving appreciated property or recognizing taxable gain on its transfer to the DAF.

Finally, the proposal to increase charitable giving by individuals is only half-baked. The ACG proposal suggests an above-the-line charitable tax deduction to encourage non-itemizers to give, but is otherwise vague. Unfortunately, the decline in giving by those of modest means is much less a problem of the tax incentives they receive than of the continued erosion of middle-class income and wealth.

Let’s be honest: For some wealthy donors, philanthropy is a tax avoidance strategy with the benefit of being an extension of personal power and privilege with numerous public relations benefits. The idea of incentivizing the middle class to move some tax revenues directly to charitable dollars, as the ACG suggests, is a good one, but should be paid for by reducing tax deductions for the wealthy.

This year of crisis has brought into sharp focus the problem of relying on rich foundations and individuals to meet philanthropic needs. Despite billionaires seeing their wealth increase by $1 trillion during the pandemic, we have yet to see any comparable boost in charitable giving. Billion-dollar foundations, including some that have endorsed ACG, refuse to dip into their overly stocked endowments to help the nonprofit community survive and address our nation’s overwhelming needs. The Crisis Charitable Commitment was launched in July to encourage foundations and wealthy individuals to step up their giving voluntarily. Among the 56 signatories to the commitment, representing nearly $300 million in charitable giving, there’s not one billionaire or billion-dollar foundation!

Instead of pretending to be charitable reform and preserving the status quo, we’d all be better served by accelerating charitable giving with simple and meaningful reforms:  (1) enact mandatory increased payout requirements for foundations and donor-advised funds; (2) reduce tax benefits for the rich in favor of incentives for lower- and middle-income charitable giving; and (3) improve efficiency by curbing obvious abuses in foundation operations, including by eliminating overhead from the payout calculation. These are reforms that would put the pedal to the metal.

Chuck Collins directs the Charity Reform Initiative at the Institute for Policy Studies, where he co-edits and co-founded the effort to press for an emergency charity stimulus. He is author of the forthcoming bookThe Wealth Hoarders: How Billionaires Spend Millions to Hide Trillions” (Polity).

Alan S. Davis is president of the Leonard and Sophie Fund, director of the WhyNot Initiative, and founder of the Crisis Charitable Commitment. He is the author of “The Fun Also Rises.”

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