Law outside the market: the social utility of the private foundation.

• Author: Schramm, Carl J.

INTRODUCTION I. A THEORY OF THE PRIVATE FOUNDATION A. The Theory B. Two Primary Functions of Foundations II. THE EVOLUTION OF OPPORTUNITY IN AMERICA III. THE PRIVATE FOUNDATION A. Development of the Private Foundation B. The Importance of Donor Intent C. Foundations as Independent and "Out-Market" Institutions 1. Education 2. Scientific Research 3. Social Policy D. External Threats to Foundation Independence 1. The Danger of Vested Interests 2. Political Threats 3. Claiming Foundation Assets for the Public Purse IV. WHY A THEORY OF THE PRIVATE FOUNDATION? A. Rising Foundation Assets and Numbers B. Evolving Problems and Criticism V. UNIQUE ASSETS OF FOUNDATIONS A. Purposefulness B. Non-Financial Foundation Assets 1. Institutional Innovation 2. Ideas 3. People 4. Leverage VI CONCLUSION INTRODUCTION

As the American private foundation moves into its second century of existence, the question of what theory guides its social utility looms as vitally important. At present, however, the foundation appears to lack any coherent theory of its role in society and the economy. (1)

The regulatory environment in which foundations operate, roughly circumscribed by the Internal Revenue Code and state "charity" statutes, offers the barest of precedent and understanding. The law is clear about the raison d'etre of foundations, namely, to pursue "charitable purposes," (2) but offers little else. Faced with an array of insistent demands, the foundation lacks a clear sense of its normative standing in relation to other institutions. Moreover, its own conception of relevance is muddled and often defined by those who solicit its funds. In the absence of a coherent thesis, government, too, can impose expectations that may destroy the foundation's ability to achieve the purposes for which it was conceived.

This Article argues that the private foundation, an institution of democratic capitalism, exists to strengthen and facilitate the mutually supporting American systems of democratic pluralism and a free-market economy. In this, foundations are circumscribed by donor intent and donor aspirations that they be purposeful, even as the objects of their efforts change through time.

Part One sets forth a theoretical framework to guide private foundations. Part Two recounts the evolution of the American economy and society over the past two centuries, connecting the vision of the entrepreneurial founders to their ongoing foundations. Part Three discusses the historical development of the private foundation, its nature as an institution, and presents illustrative examples of foundations supporting economic growth and human welfare. Part Three then concludes with a discussion of external threats facing the foundation today. Part Four explores the utility of a theoretical framework for foundations, and Part Five discusses the unique assets foundations bring to this task. The conclusion sets forth a new rule of presumptive continued private action for foundations based on an informal treaty among founders, trustees, and governmental oversight authority.

1. A THEORY OF THE PRIVATE FOUNDATION

   Existing theories about the social utility of the private foundation inadequately explain its role in society, and previous attempts to promulgate a guiding theory have fallen short. Perhaps the two most prominent efforts to lay out visions of foundation philanthropy were the Peterson and Filer Commissions.

   In 1969, John D. Rockefeller III formed the Commission on Foundations and Private Philanthropy, chaired by Pete Peterson, in response to a "gathering storm" in Congress regarding foundation regulation. (3) The Commission's report, however, was published after passage of the relevant legislation, blunting its impact. (4)

   The Filer Commission, formally the Commission on Private Philanthropy and Public Needs, was chaired by John Filer and operated from 1973 to 1977. It was also formed by Rockefeller, but was fractured by dissent and resistance and failed to achieve Rockefeller's mission of presenting "a bright new vision of philanthropy's role in meeting social needs." (5)

   1. The Theory

      Today, absent a consensus view of their social utility, foundations are variously said to be supporters of "social capital" promoters of civil society, and providers of public goods. (6) Some declare the "sole justification" of the private foundation to be sustenance of "the grant seekers." (7) In part because of their abstract generality, however, none of these proffered purposes succeeds in providing a coherent framework to guide foundations in the constantly shifting environment in which they exist.

      If one examines the emergence of private foundations, their historical behavior, and their institutional character, a new conception of their social utility becomes clear. The private foundation is an institution inextricably linked to the workings of a free-market economy, and it exists to promote and preserve the democratic pluralism underlying that economic structure. With its enormous ability to advance these principles, a foundation's efforts must be guided by donor intent and the injunction that it engage in purposeful activity: it must not actively or inadvertently work to subvert democratic capitalism.

   2. Two Primary Functions of Foundations

      As an institution born out of democratic pluralism and a free-market economy, the foundation fulfills two functions: it serves as a mechanism for the reconstitution of wealth, and it plays the role of institutional entrepreneur, challenging other social institutions.

      A clear sensibility of usefulness runs through American history--of applying wealth and knowledge to create expanded opportunity and participation that will generate greater wealth and individual freedom. (8) It is here that the private foundation plays an underappreciated but central role in our nation's institutional framework as a mechanism of wealth reconstitution.

      Once wealth is created in democratic capitalism, it can be directed to one of several outlets. First, wealth can vacate the system and tie itself up in building aristocratic dynasties. This runs against the grain of American sensibilities, however, and has rarely been the case, particularly when America is compared with European countries in this regard. (9) Second, the government can place wealth in the control of the state through taxation. Although the government helps prevent the establishment of dynasties (through, for example, the estate tax), concentration of wealth in the state poses another set of problems. (10)

      Neither of these two options is desirable because both harm democratic capitalism. A better use of wealth is capital reinvestment, which strengthens the system's infrastructure and results in innovation. This, in turn, leads to an expansion of wealth.

      Finally, an equally important use of wealth is philanthropy, particularly the endowment of private foundations. This reconstitution is intended to apply wealth in ways that preserve democratic pluralism and a free-market economy, thereby promoting the "release of human possibilities," (11) as intended by foundation donors.

      The second essential social function performed by the private foundation is that of institutional entrepreneur. When describing the nature of progress and innovation, famed economist Joseph Schumpeter focused on the disruptive role of entrepreneurs. Because the institutional actors in any system will often tend toward equilibrium--Schumpeter's static "circular flow"--an economy will regenerate and living standards will improve only when entrepreneurs disrupt that static equilibrium and the vested interests that accumulate along with it. (12)

      Private foundations play this role in society. Creations of successful entrepreneurs who seek the reconstitution of wealth, foundations are conceived as having the particularistic entrepreneurial role of challenging other institutions to continuous renewal. In this way, foundations break the static equilibrium toward which social institutions gravitate and allow the economy's welfare-generating capabilities to continue to expand efficiently and effectively.

      This institutional disruption and resulting economic expansion also works to promote democratic pluralism. History has proven that diffusion of the benefits of progress occurs through neither the ministrations of "professionals" and "experts" nor the inexorable march of sweeping historical forces, but through the evolution and expansion of opportunity, expressed in the various and deliberate acts of individuals. Individual liberty and freedom lie at the heart of the American experiment, and American society has traditionally fostered the pluralism that preserves them. Frequently, this pluralism finds expression in free-market economic activity that then reinforces individual liberty. (13) Private foundations, which owe their existence to a regime of individual liberty and property rights, stand squarely within this tradition. (14)

      There appears to be a widespread sense, however, that many large foundations have, in the last few decades, retreated to small ideas and scaled down visions of their social utility. (15) With some prominent exceptions, many have arguably missed the changes in our economy and society and the evolving needs and opportunities those changes present. (16)

      Most large foundations were established by entrepreneurs who changed the world with bold risk-taking in their business practices and expected no less from their foundations. (17) The courage to take risks and inspire progress remains at the core of foundations today, but the strategies used must evolve as the nature of social problems changes. (18)

2. THE EVOLUTION OF OPPORTUNITY IN AMERICA

   In democratic capitalism, the reinforcing characteristics of pluralism and a free-market economy create and expand opportunity. (19) As Brian O'Connell notes, "business and free enterprise [are] pivotal factors in the development and effectiveness of our civil...