Who Benefits from the Nonprofit Sector?

• Author: Ben-Ner, Avner

Charity commonly is defined as "generous actions or donations to aid the poor,"(1) or "provision for those in need."(2) Members of the public and the legal community believe that charity is the primary undertaking of nonprofit organizations,(3) and this perception provides apparent justification for the diverse tax privileges and other advantages that nonprofit organizations enjoy.(4) Whether these privileges and advantages are aimed at rewarding or encouraging charity by nonprofit organizations,(5) the existence of such privileges creates the expectation that nonprofit organizations should provide some measure of charity.(6)

Although most charity is performed by nonprofits, charity is only one of the many activities of the nonprofit sector.(7) A series of studies commissioned by Charles T. Clotfelter, collected in Who Benefits from the Nonprofit Sector?,(8) demonstrates that charity is only a marginal pursuit of the nonprofit sector in every area in which nonprofit organizations are prominent: health, education, religion, social services, arts and culture, and foundations. The book's editor cogently summarizes the conclusions of the six studies:

First, there is great diversity within the nonprofit sector, and no

overarching conclusions about the distributional impact can be made.

This said, a second finding is one stated in the negative: in no

subsector is there evidence that benefits are dramatically skewed away

from the poor and toward the affluent. Conversely, there is also

evidence that relatively few nonprofit institutions serve the poor as a

primary clientele. A third general conclusion is that an institution's

source of funding appears to be important in determining the

distribution of its benefits. Institutions which receive funding that is

tied to certain objectives or recipients will tend to make expenditures

reflecting those requirements.(9) In short, the organizations that constitute the charitable sector (as defined by section 501(c)(3) of the Internal Revenue Code) are not primarily charitable.(10)

The publication of Who Benefits? coincided with a spate of media reports asserting that nonprofit organizations frequently engage in activities unrelated to their presumed charitable missions, and that executives of nonprofits plunder their organizations' resources.(11) The reports have engendered recent efforts by nonprofit sector insiders, legislators, and state attorneys general to force a greater measure of charitability upon nonprofit organizations, to make them more accountable, or even to strip them of some of their privileges and exemptions.(12) Unfortunately, much of the policy debate is informed more by unjustified assumptions, assertions, and expectations than by empirical evidence and a theoretical understanding of what distinguishes the nonprofit sector from the for-profit and government sectors.

There is no question that reform of the nonprofit sector is in order; as the studies in Who Benefits? demonstrate, the gap between our perception and the reality of nonprofit organizations is widening. Some nonprofit organizations fulfill primarily charitable functions--they distribute to the poor, in various forms, most of the contributions they receive. Most nonprofit organizations, however, are involved in activities that are not specifically directed at the poor or needy. Although nonprofit hospitals, universities, museums, orchestras, theaters, libraries, and other organizations may serve poor clients, at times charitably, few of these organizations can credibly claim that serving the poor is among their central goals, or that they serve other groups primarily to raise funds to subsidize goods or services for low-income customers.

What is to be done? This Review looks to the forces that lead to the creation of nonprofit organizations for answers. Nonprofit organizations, whether or not they are true charities, come into existence when for-profit firms and the government fail to meet the demands of certain groups in a particular market. Examples of demands that may go unmet include the demand of donors to support the poor, the demand of some parents for quality day care for their children, or the demand of some theatergoers to view certain plays. A for-profit firm may not meet the demand of a particular market when consumers, sponsors, or donors lack adequate information to monitor and evaluate a for-profit firm's services and use of resources. The government, in turn, fails when it cannot correct the failures of for-profit firms--often because of the particular way that the government makes political decisions regarding its activities.

When consumers, sponsors, and donors experience unsatisfactory services, they seek to alleviate the problem. For example, they may seek additional information about the operation of a day care center, use a suggestion box at the theater to identify plays that they would find interesting, or lobby the local government for changes in nursing home care. Those who remain dissatisfied may benefit from an alternative that deals with the root of their difficulties--that is, a remedy that addresses the problems of information associated with providing such services under a profit-driven form of organization. Nonprofit organizations offer such a remedy when they pursue the objectives of consumers, sponsors, and donors and do not take advantage of information they possess to turn a profit. Those who may benefit in this sense from the operations of a nonprofit organization may be said to have an economic demand for the nonprofit form. Demand for the nonprofit type of organization, therefore, originates with those who pay for the provision of a service but are dissatisfied with for-profit or governmental methods of provision.(13)

This Review argues that those who have an economic demand for the nonprofit form are in the best position to ensure that a nonprofit organization actually does improve upon a for-profit firm's provision of services. The shortcoming of nonprofit firms, identified in Who Benefits? and elsewhere, can therefore best be addressed by a legal and policy framework that enables those with a demand for a nonprofit organization to control the organization's management. Such control is necessary to ensure that nonprofits efficiently pursue the objectives of consumers, sponsors, and donors. Nevertheless, the ability of most members of this group to exercise effective control over management is limited for the same reasons that small shareholders can exert little control over large for-profit firms.(14) Rectifying this situation, this Review suggests, requires improving access to the decision-making process of nonprofit organizations by consumers, sponsors, and donors and allowing them to assert more oversight of management. Such reforms should enhance support for nonprofit organizations: More donors will feel confident that their contributions are being used properly, more theatergoers will attend the productions they wish to see in nonprofit theaters, and more parents will choose to send their children to day care centers that cater to their preferences.

Part I of this Review examines evidence of the distributional effects of nonprofit activities presented in Who Benefits?. Part II first explores the advantages and disadvantages of policies aimed at enhancing redistribution by the nonprofit sector. After arguing that such enhanced redistribution is neither feasible nor desirable, I present a theory of nonprofit organizations focusing on market and govenment failures that create dissatisfaction among consumers, sponsors, and donors. Finally, I discuss the difficulties of exercising control over nonprofit organizations.

I propose several policies that would alleviate this control failure and thereby enhance the effective operation and governance of nonprofit organizations. I propose to accord legal "member" status to those consumers, sponsors, and donors who can be identified as having an economic demand for specifically nonprofit provision and to strengthen the fiduciary role of state government vis-a-vis nonprofit organizations on behalf of these groups. Members' rights should include improved access to information about organizations, a power to vote (with a weight proportional to contributions) for the board of directors and on matters of great importance, and legal standing in court to challenge mismanagement. State governments should help nonprofit organizations involve their members in governing; mediate disputes between members, management, and directors; and act (in extreme cases) as agents for inactive members. These measures would ensure that nonprofit organizations are governed by those who actually support them--or who would support them if they were allowed access to decision making--and would limit the ability of management to operate without accountability.

In addition, such policies would eliminate the need for many of the tax and other special benefits nonprofit organizations now enjoy. Nonprofit management opposed to increased accountability should be allowed to incorporate as some variant of a for-profit firm. "Nonprofit" status then would mean, in addition to the vague and seldom-enforceable noninurement restriction it currently represents, that an organization has real accountability to those who have a specific demand for nonprofit provision of services. Concern for the provision of services to the poor and other groups can be more effectively addressed by policies that focus directly on these services than by current broadbrush policies that regulate the nonprofit sector as a whole.

1. WHO BENEFITS FROM THE NONPROFIT SECTOR?

   With the nonprofit sector producing nearly one-tenth of the gross domestic product (GDP) and playing a dominant role in the health, social services, education, and high-culture industries,(15) and with major reforms underway in several of these industries, crafting a policy directed specifically...