Pay it forward? Law and the problem of restricted-spending philanthropy.

• Author: Galle, Brian
• Position: IV. The Value of Future Spending B. New Arguments for Restricted Spending through Conclusion, with footnotes, p. 1176-1207

2. New Arguments for Restricted Spending

   In addition to the possibilities other commentators have raised, I want to raise some additional potential benefits from the accumulation of wealth by philanthropic organizations. In earlier theoretical work, I argued that the best justification for subsidies for the charitable sector may be the sector's potential to achieve what local governments cannot: spend during times of acute need, compete effectively with the federal government, and conduct guided policy experiments, among other goals. (154) Each of these three achievements likely requires some buildup of charitable assets over time. I'll now claim, however, that rather than prescribing accumulation of unlimited wealth over endless periods of time by private foundations, these policies generally weigh in favor of limited savings, call for occasional aggressive spending, and may make more sense for operating charities than private foundations.

   As a prelude to this analysis, I should mention that the traditional rationale for government support of charities is that charity is basically a delivery vehicle for positive externality goods that neither government nor market would otherwise provide. (155) So, for example, charity can pursue goals that could not command a majority of voters. In this Subpart, I will build on some additional examples of instances in which charities can succeed while governments fail.

   1. Crisis Spending

      One key example where governments predictably fail is crisis spending. (156) Private citizens should want to buy insurance or build up a buffer stock of savings against the possibility of bad times, such as natural disasters or recessions. (157) But because of asymmetric information between individuals and insurers, markets for these kinds of insurance are overpriced, unavailable, or otherwise "incomplete," which is a nice way of saying that they fail. (158) Governments can and often should step in to provide fallback social insurance, whether in the form of disaster insurance, unemployment insurance, or fiscal stimulus (that is, extra spending or tax cuts) during recessions. (159) However, for a variety of reasons I have sketched in earlier work, government--especially state and local government--also performs poorly during recessions. (160) Historically, US states have tended to cut spending and raise taxes during recessions, which is the exact opposite of what they should be doing. (161) Federal relief arrives more consistently, but often at the wrong times and aimed at the wrong people. (162)

      Nonprofits can and should step in to fill this gap, but they face some practical obstacles in doing so. Donations to charity fall during recessions. (163) Logically, donors are more likely to give when they have more available, and recessions can squeeze even the most generous. Wealthy individuals with no credit constraints, however, should be indifferent to current market fluctuations: they should anticipate that markets will rebound, and donate out of future wealth. (164) That they seem not to fully do so tells us that the dip in giving may also be attributable to some other factor, such as tax policy.

      Tax incentives for giving are also weaker during recessions. As current incomes fall, so do marginal tax rates, reducing the size of the government's matching grant. (165) Further, recall that a major tax advantage for donations of securities is that they allow the donor to deduct the full value of the security, without paying tax on the gains. During recessions, when the stock market is weaker, the securities held by potential donors are usually worth less, making both of these tax incentives less valuable. (166)

      Foundations might therefore serve as private piggy banks for the charity world. Governments would like to save for future crises, but struggle to do so in the face of political preferences for the present. Tax subsidies for foundations would be the equivalent of a government contract with private parties to save in government's stead.

      Even so, private foundation savings may not contribute much to the problem of crisis spending. Instead of paying for foundation savings, government could find ways of encouraging greater donations during times of need, as it did following Hurricane Katrina and other recent disasters. (167) That would tend to reduce the need for charities to build up funds in anticipation of crises. On the other hand, it might be difficult for operating charities to absorb huge influxes of new funds over short periods. (168) But that still doesn't necessarily support foundation savings since new funds would be hard to absorb, whatever their source. It might be better for the operating charities to decide for themselves when to save and when to spend; for then such charities might use excess funds during non-crisis times to build infrastructure and response capabilities.

      Another difficulty with offering more generous subsidies for new donations in times of need is that donor responses to crises can also be somewhat inefficient, with gifts flowing to areas that get more press coverage, rather than those that may offer the greatest social benefit. (169) On that front, at least, foundations can help by using more rigorous methods for directing funds. (170)

      Whatever the theoretical case for private foundation savings as a cure for crisis, in the real world, private foundations don't seem to pursue that goal. Foundation spending is flat or lower during recessions. (171) As a result, it is difficult to justify current foundation limited-spending policies on the basis that these policies allow for greater spending when economic need is greatest. In Part V, I discuss some possible ways in which a limited-spending rule could be reshaped to better fit with this goal.

   2. A Federal Alternative

      A second instance where federated government often fails to produce a diverse array of policy choices for citizens is in the delivery of public goods whose benefits are spread relatively thinly across many different states. (172) When benefits spill over in this way, it is rational for each state and local government to aim to free ride on the efforts of others, and assembling an inter-jurisdictional special government entity to deal with the problem is costly and politically fraught. (173) As a result, the national government rarely has direct state competitors in important policy areas such as international aid, wildlife and natural resource conservation, basic science funding, and the like. (174) Charities offer the public an alternative to exclusive reliance on their national elected officials, and by providing competition or a yardstick for comparison can help to force those officials to perform better. (175)

      We live in a big country, though, with big problems. The federal alternative story may require similarly large stores of charitable resources. Perhaps to be effective at the regional or national level, the charitable sector must build a deep pool of funds. (176)

      As with crisis spending, it isn't clear that foundation savings are the best source of savings for this kind of future need. As national aggregator organizations such as the United Way show, the resources to achieve national influence need not come from one donor, whose seed money must then snowball over time. Put another way, the national influence story doesn't clearly establish whether any particular donation should be used for one large project or instead for a steady stream of small ones.

      Further, operating charities, too, can build their resources to the point where they can be effective across a wide geographic area. Operating charities might also be perfectly effective if there are many small organizations that in the aggregate are able to get things done. That is largely the model of US international aid organizations; basic science, similarly, can be funded a handful of labs at a time. (177) Or national influence service organizations could be funded with an ongoing, rolling stream of contributions from individual donors and moderate-sized foundations. On the other hand, having centralized funding to guide and evaluate new projects is likely important to their ultimate success.

      Nor does the need for large organizations justify government support for gifts with indefinite or inflexible restricted-spending provisions. It may take time to build a firm to the point where it can meaningfully pursue nationwide projects. But at some point the firm reaches that scale. Under a restricted-spending rule, the time it takes the firm to achieve the appropriate scale for a national-level project is far longer: because the firm is bound to spending only a small fraction of its assets each year, it must wait until its assets grow to something like twenty times the annual spending it will need. (178) In contrast, a firm that was free to spend, say, twenty percent of its assets in a year could launch its project far sooner. (179)

      In short, a firm with national ambitions must be free to spend in large chunks at times when an opportunity to effect broad change arises. While foundations are a vital alternative to government, there is little reason to believe that ever greater wealth accumulation is necessary for, or even consistent with, that goal.

3. A Review

   Let's step back for a moment to assess where the argument so far has taken us. As I've framed it, the basic question is whether subsidizing restricted-spending charity is a better use of the government's resources than other alternatives. One alternative would be for the government to invest its money, and then later devote the resulting payoff to charity or some other worthwhile project. Another would be to fund charities that will spend the subsidy relatively quickly.

   While I cannot put precise numbers on any of the three options, the analysis so far suggests that restricted spending, except within certain limits, usually will have less value than either of the other...