Social Technology & the Origins of Popular Philanthropy

• Citation: Vol. 32 No. 2
• Publication year: 2016
• topic: Charity and Non-Profit Law,Tax Law

Social Technology & the Origins of Popular Philanthropy

Brian L. Frye

University of Kentucky School of Law

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SOCIAL TECHNOLOGY & THE ORIGINS OF POPULAR PHILANTHROPY

Brian L. Frye^*

Abstract

The prevailing theory of charity law holds that the charitable contribution deduction is justified because it solves market and government failures in charitable goods by compensating for free riding on charitable contributions. This Article argues that many market and government failures in charitable goods are actually caused by transaction costs, and that social technology can solve those market and government failures by reducing transaction costs. Specifically, it shows that in the early twentieth century, the social technology of charity chain letters solved market and government failures in charitable contributions and facilitated the emergence of popular philanthropy.

Introduction

On September 6, 1901, Leon Czolgosz assassinated President William McKinley.¹ Later that month, a group of McKinley's friends formed the McKinley National Memorial Association and launched an international fundraising campaign to build a monument to McKinley.² The campaign soon raised more than $500,000 and

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enabled the Association to build the McKinley National Memorial in Canton, Ohio, which was dedicated in 1907.³

At the same time, an unknown number of people used charity chain letters to launch their own independent fundraising campaigns for the McKinley Memorial.⁴ The chain letters asked recipients to send a few cents to the McKinley National Memorial Association and to continue the chain.⁵ They were remarkably successful, raising money from hundreds of thousands of donors.⁶

Popular or "mass" philanthropy is public participation in national charitable activity.⁷ The prevailing view of popular philanthropy holds that it emerged in the early twentieth century in response to a new "culture of giving" created by national fundraising campaigns.⁸ This Article shows that members of the general public simultaneously created independent fundraising campaigns using charity chain letters and suggests that social technology, rather than ideology, may have provided the catalyst for the emergence of popular philanthropy. It argues that national fundraising campaigns and charity chain letters were social technologies that enabled the public to solve "charity failures" and engage in public philanthropy by reducing transaction costs. Finally, the Article also observes that modern social technologies like crowdfunding use similar methods to accomplish the same goal.

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I. Charity Law, Charity Failures & Social Technology

The prevailing theory of charity law is the economic subsidy theory, which holds that charitable contribution deduction is justified because it solves market and government failures in charitable goods.⁹ "Market failures" are inefficiencies in the market's allocation of a good, and "government failures" are inefficiencies in the government's allocation of a good.¹⁰

"Public goods" are goods that are non-rivalrous and non-excludable.¹¹ In other words, consumption does not reduce supply and cannot be prevented.¹² Public goods are vulnerable to market failures caused by "free riding," or consumption for less than the marginal cost of production.¹³ Producers tend to undersupply public goods because they cannot recover the marginal cost of production.¹⁴

"Charitable goods" are goods that are provided altruistically by individuals or organizations.¹⁵ Some charitable goods are literally public goods. For example, public art is essentially non-rivalrous and non-excludable.¹⁶ Other charitable goods resemble public goods because they are ideally available to anyone in need.¹⁷ For example, food banks ideally provide an adequate quantity of food to all comers.¹⁸ Moreover, consumers of charitable goods generally do not pay or cannot pay the marginal cost of production.¹⁹ As a consequence, charitable goods often resemble public goods, and are typically also vulnerable to market failures caused by free riding.

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Government can solve market failures in charitable goods by directly subsidizing them.²⁰ However, direct subsidies are vulnerable to government failures caused by politics and other transaction costs.²¹ For example, governments tend to directly subsidize charitable goods demanded by political majorities, but tend not to directly subsidize charitable goods demanded by political minorities.²² This is essentially a form of information cost, as politics is a means by which the government gathers information about public demand.²³ Governments may also incur other information costs in determining which charitable goods to directly subsidize.²⁴ For example, governments may find it difficult to determine which subsidies will produce the largest public benefit.²⁵

The public can solve market and government failures in charitable goods by providing charitable contributions.²⁶ However, altruism is vulnerable to market failures caused by free riding and transaction costs.²⁷ Altruism is vulnerable to free riding on charitable contributions because donors cannot consume the public benefit created by their donation.²⁸ But altruism is also vulnerable to transaction costs because donors must internalize both the cost of a charitable contribution and any transaction costs associated with that contribution.²⁹

The economic subsidy theory of charity law provides that the charitable contribution deduction is justified because it solves market and government failures in charitable goods by indirectly subsidizing charitable contributions.³⁰ The charitable contribution deduction

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allows donors to deduct charitable contributions from their income tax base under certain circumstances, thereby providing an indirect subsidy.³¹ According to the economic subsidy theory, this indirect subsidy provides an incentive to marginal donors and thereby solves market and government failures in charitable goods by compensating for free riding on charitable contributions.³²

The economic subsidy theory of charity law implicitly predicts "charity failures," or inefficiencies in charity law's allocation of charitable goods caused by the charitable contribution deduction.³³ The charitable contribution deduction is vulnerable to charity failures because the subsidy it provides is determined by an endogenous variable and because it cannot provide a salient incentive to most donors.³⁴ The indirect subsidy provided by the charitable contribution deduction is determined by the marginal income tax rate of the donor, which is unrelated to the amount of free riding on the charitable good it subsidizes.³⁵ In addition, it cannot provide a salient incentive to the overwhelming majority of donors who do not itemize their taxes and therefore cannot claim the deduction.³⁶ As a result, the charitable contribution deduction should cause charity failures in charitable contributions from low-income donors, who receive little or no subsidy because they have a low marginal income tax rate and rarely itemize.³⁷

Social technology can solve charity failures by reducing transaction costs on charitable contributions, rather than subsidizing

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them.³⁸ Social technology is the use of knowledge of the facts and laws of social life to achieve social goals.³⁹ For example, crowdfunding is a social technology that uses the Internet to enable people to raise money by asking the public for small contributions.⁴⁰ Crowdfunding is successful because it reduces transaction costs on charitable contributions, solving market failures in charitable contributions by making charity more efficient.⁴¹ Among other things, crowdfunding reduces information costs by making it easier for marginal donors to identify worthy recipients, reduces bargaining costs by making it easier to determine the efficient donation, and reduces enforcement costs by making it easier for donors to monitor compliance.⁴²

II. A Potted History of the Charitable Sector

A. Charity in Colonial & Antebellum America

In antebellum America, charity and charitable organizations were common, but almost exclusively local.⁴³ Colonial Americans "shared the traditional Protestant emphasis on the individual's responsibility for the spiritual and material welfare of the community" and formed innumerable voluntary organizations in order to provide for community needs.⁴⁴ As Alexis de Tocqueville observed in 1835:

Americans of all ages, all conditions, and all dispositions, constantly form associations. They have not only

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commercial and manufacturing companies, in which all take part, but associations of a thousand other kinds—religious, moral, serious, futile, general or restricted, enormous or diminutive. The Americans make associations to give entertainments, to found seminaries, to build inns, to construct churches, to diffuse books, to send missionaries to the antipodes; and they found in this manner hospitals, prisons, and schools. If it be proposed to inculcate some truth, or to foster some feeling by the encouragement of a great example, they form a society.⁴⁵

Early American voluntary organizations took a variety of forms and were intended to address practical problems.⁴⁶ Some were charities intended to provide a public benefit, like churches, schools, and poorhouses.⁴⁷ Others were clubs intended to benefit their members⁴⁸ like Benjamin Franklin's Junto.⁴⁹

Early Americans were suspicious of charitable trusts and corporations, which many saw as a threat to republican values, because they could exist in perpetuity.⁵⁰ For example, in 1819, New Hampshire famously tried to change Dartmouth College from a private organization to a public organization by changing its corporate charter but was prevented by the Supreme Court.⁵¹ As a result, national fundraising campaigns were rare and rarely successful.⁵² Charitable organizations tended to address a limited number of social issues in a limited geographical...