Are foundations elitist, anti-democratic, and in danger of losing their tax exemptions?

Who's giving, who's getting.
Feb. 16 2007 7:30 AM

Uncharitable Thoughts

Are foundations elitist, anti-democratic, and in danger of losing their tax exemptions?

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Joel Fleischman's book The Foundation.

For most of the 25 years since its creation, no foundation was more inscrutable than the Atlantic Philanthropic Service Corporation, the American division of the international Atlantic Philanthropies. It accepted no unsolicited proposals for funding and made grants anonymously. In 2001, the foundation drew attention when it dropped its policy of anonymity, to increase "effectiveness, transparency, and accountability." In 2002, the attention turned into a flurry of publicity when it decided to give away all of its remaining assets—$3.1 billion at the end of 2005—by 2020. Having adopted the mantra of "giving while living," it sought to persuade other philanthropies to do the same.

Joel L. Fleishman was the foundation's president from 1993 until 2001, when it was operating in the shadows. But in his new book, The Foundation: A Great American Secret, Fleishman contends that the foundation world "seriously underperforms"—and that the antidote is the formula Atlantic Philanthropies adopted after he departed. His conviction can be understood as that of a belated convert, and one with a message of alarm. He warns that if foundations don't make themselves transparent and accountable, they will stoke the growing hostility to them in Congress and could even end up losing the source of their money and power, their tax-exempt status.  

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Especially because you've probably never heard of Fleishman, it's hard to pick a better envoy of the philanthropic establishment. Now 72 and a professor of law and public policy at Duke University in his native North Carolina, he is a behind-the-scenes connector. He is chairman of the board of the Urban Institute in Washington, D.C., and of the visiting committee of Harvard's Kennedy School of Government, among other appointments, and is a board member of the Boston Scientific Corporation. (For many years, he had a side gig as the wine columnist for Vanity Fair.)

Fleishman believes that America's civic sector is its "third great force," along with our Madisonian system of government and market economy. Through churches, universities, and other nonprofit organizations, the civic sector now employs 10 percent of the work force and accounts for almost 10 percent of the country's gross domestic product. Fleishman explains how foundations, in particular major ones bearing the names of self-made men like Carnegie, Ford, and Rockefeller, have put concentrated wealth behind the civic sector and, as a result, been a remarkable force for good. Carnegie money built 2,500 public libraries so poor people could gain knowledge to lift themselves out of poverty. Ford money was essential to the success of the civil-rights movement. Rockefeller money launched the Green Revolution, which developed new types of corn, rice, and wheat and saved a billion people from starvation. In 2005, foundations controlled half a trillion dollars and made grants totaling $33.6 billion. They're a social force unmatched by the equivalent in any other nation.

Yet Fleishman acknowledges that the arrogance of the foundation world has led it to miss good ideas developed by others. Its insulation has allowed it to proceed without being challenged by external forces, and without understanding much about the success or failure of its programs. Its invisibility has left it isolated, risk averse, and without much public support.

The heart of Fleishman's prescription for self-improvement is the investmentlike approach of the highly respected Edna McConnell Clark Foundation, which has supported the development of Geoffrey Canada's Harlem Children's Zone. The idea is to make fewer, bigger grants and longer-term commitments, while rigorously evaluating each one before making it and ruthlessly measuring the results. This model has taken the lead in the civic sector during the past decade, so Fleishman's program contains no big surprises. Because of his eminence in the sector, it's like the church's endorsement of a new order.

What's startling, though, is that, despite the book's argument for transparency, it has another, not-quite-transparent agenda. Foundations benefit from federal and state tax rules that give people incentives to donate to them and that shelter the growth of their wealth. Foundations pay only a small federal foundations tax (a 1 percent or 2 percent excise tax on net investment income). * Society gives up tens of billions of dollars to support them. But Fleishman worries it may not always be so. He writes, "The risk that foundations could lose their tax-exempt status is not theoretical." Congress is "signaling its desire to take a closer look at whether foundations are fulfilling their social obligations" and, as a result, "the whole cloth of foundation regulation could be on the cutting table."

Without their tax-exempt status, Fleishman fears, foundations could find themselves "under the thumb of government" and lose the "unfettered freedom" that has made them so valuable. He doesn't spell out this threat, alluding only to a possible "new round of retaliatory federal legislation," but says the threat must be taken seriously because of its bipartisanship: "Today's most vociferous critics come from every position on the political spectrum."

The potential drama here is underscored by a parallel weakness of foundations and federal courts. Both institutions are accused of being anti-democratic. They are criticized as elitist (by liberals who criticize foundations for representing a harmful concentration of wealth and power) and activist (by conservatives who criticize liberal foundations of disregarding the intent of conservative donors and liberals who criticize conservative foundations for engaging in politics under the cover of nonpartisan status). The courts have been hounded relentlessly. Under the right circumstances, the situation could be worse for foundations because, while the courts are enshrined in the Constitution, foundations have no such safeguard.

Are foundations seizing power and usurping roles that belong to government—or helpfully redressing its failures? These questions come up all the time among observers of foundations and those who lead them. There's rarely a simple answer, especially when being anti-democratic, carefully defined, may be a good thing. It's widely agreed that the American system of democracy needs serious repair. In addition, foundations are often the first to recognize that it's essential to work with government and marshal its much greater resources in service of their causes.

Fleishman provides no convincing proof that foundations are about to lose their tax-exempt status. But there's plenty of evidence that the civic sector is coming under increasing scrutiny in Congress. Sen. Chuck Grassley, the Republican from Iowa, likes to say that the federal tax laws governing nonprofits have hardly been touched since America first put a man on the moon, and that it's about time to change that. He cites the United Way scandal and Red Cross controversy of recent years for causing a breach of trust between "even the most reputable charities," including foundations, and the public. The sweep of reform proposed in response to such critiques is worrisome. Perhaps Fleishman is right that the concern is not whether foundations are anti-democratic, but how to keep our democracy from becoming anti-foundation.

Correction, Feb. 16, 2007: The original sentence said that foundations pay no tax on their income and the growth in value of their investments. They pay a 1 percent or 2 percent excise tax on net investment income. (Return  to the corrected sentence.)

Lincoln Caplan is a partner in SeaChange Capital Partners, a new nonprofit finance firm, and a visiting fellow at Yale's Whitney Humanities Center.