How unintended effects of tax-code changes will hurt NC nonprofits

As I often tell my students on the first day of class, there is no such thing as “the” nonprofit sector. Rather, it is an eclectic set of organizations of diverse sizes, missions and operations that is tied together by the Internal Revenue Code on the federal level and corporation law on the state level.

This diversity is what makes it fun to research and teach about the roles these organizations play in society and about the economic and social effects they have on our communities.

However, this diversity can make predicting effects of policy changes difficult. Two changes being discussed as part of our state’s next budget – a cap on sales tax refunds and a cap on an individual’s charitable deductions – have the potential for unintended consequences.

A lot of the rhetoric around the sales-tax refund has focused on large nonprofit hospitals with implicit questions about whether they are “deserving” of this and other tax breaks. Many complain that such tax breaks give nonprofit hospitals an unfair competitive advantage relative to for-profit hospitals. On the surface, this argument makes intuitive sense, until you begin to consider how these tax breaks are actually used by nonprofit hospitals.

Nonprofits cannot distribute their net earnings at the end of the year to people who oversee the organization. Unlike a for-profit hospital’s fundamental mission, which is to increase shareholder value, a nonprofit hospital’s mission is to improve its community’s health. While these tax breaks can reduce a nonprofit hospital’s cost of operations relative to a for-profit hospital’s costs, unlike in a for-profit hospital, they cannot be given to shareholders. They are used to provide benefits to their community.

More importantly, research bears this out. Nonprofit hospitals tend not only to have better patient outcomes than similar for-profit hospitals (typically because nonprofit hospitals have more registered nurses on staff) but also to provide higher levels of benefit to their communities beyond better patient care. In large part, nonprofit hospitals are able to achieve these community-benefiting outcomes because of these tax benefits.

Limiting sales tax refunds for hospitals to make competition with for-profit hospitals “fairer” would have the unintended consequence of reducing their ability to provide better patient care and community benefit. Beyond the unintended effects this policy could have on nonprofit hospitals, given the aggressive reduction in the cap proposed by the North Carolina Senate’s budget, nonprofit colleges and universities, churches and other organizations would be faced with making similar choices of reducing the benefits they provide to their communities as they face increased costs of operations.

The limit on charitable deductions for individuals who itemize deductions on their state income tax returns also has the potential for unintended consequences. Americans donate about 2 percent of GDP (plus or minus a couple of tenths of a percent, which in an $18 trillion economy is serious money but still marginal in relative terms) annually regardless of health of the economy or marginal tax rates. Such a trend lends credence to policymakers’ observations that charitable giving is relatively price-inelastic and that charities will see very little reduction in giving. Once again, on the surface such an insight may make intuitive sense, but the evidence is much more nuanced.

Most individual philanthropy (about 70 percent) goes to those charities with services we use. These charities tend to be our houses of worship, art museums, our college and university alma maters and organizations fighting diseases that have affected our loved ones. In general, donations to these types of nonprofits will not decrease because of changes in the tax deductability of donations by people who itemize deductions on their North Carolina state income taxes. However, a cap on charitable tax deductions would affect that other 30 percent of donations that tend to go to social service nonprofits that primarily serve struggling individuals and families in our communities. Such a change in our state’s tax code would lead to a reduction in the ability of our nonprofits to assist our neighbors across our state.

There is no such thing as “the” nonprofit sector. The proposed changes in our state tax code targeted at specific types of nonprofit organizations would have unintended consequences not only on the target organizations but also on the ability of other nonprofits to impact the economic and social fabrics of our communities.

This story was originally published July 2, 2015 at 1:23 PM with the headline "How unintended effects of tax-code changes will hurt NC nonprofits."