Philanthropy

A Conversation with Hoover Institution Senior Fellow John H. Cochrane

The finance economist and popular blogger talks to Michael E. Hartmann about nonprofitdom’s tax-favored legal structure, which he thinks we should consider scrapping.


John H. Cochrane got our attention last month with his remarks on Tyler Cowen’s podcast about the tax-favored legal structure of nonprofitdom in America. “Let’s get rid of the entire legal structure of the nonprofit organization,” Cochrane passingly mused. “[N]onprofit status in the U.S. has been, like everything else, horribly misused. Now it’s a cover. A lot of it is a cover for getting out of the estate tax and for subsidizing political activity at taxpayer expense.”

Well, we thought that worthy of at least a brief conversation with Cochrane, which he was kind enough to have with me last week.

Cochrane is the Rose-Marie and Jack Anderson Senior Fellow at the Hoover Institution, a research associate of the National Bureau of Economic Research, and an adjunct scholar of the Cato Institute. He is a former professor of finance at The University of Chicago’s Booth School of Business, and he blogs at The Grumpy Economist.

The below audio of our discussion is 15 minutes. An edited transcript follows.

Hartmann:  I’m Mike Hartmann, one of the three co-editors of The Giving Review. John Cochrane is nice enough to give us some time to talk briefly today about something we heard him say on a podcast that we’d like to just get into for a little bit.

John Cochrane is a senior fellow at the Hoover institution at Stanford University out west. He moved there, I think, from Chicago, where you were a professor at The University of Chicago’s Booth School of Business—so we lost a good Midwesterner maybe, we’ll ask him about that—and he’s an adjunct scholar at the Cato Institute, as well.

He blogs at The Grumpy Economist. We’ll see if we can get him to be grumpy here today.

Let me just describe why we are trying to talk to you a little bit more here. In an appearance on Tyler Cowen’s podcast, I think last month, John made an observation about nonprofitdom, nonprofit status. Tyler and John were talking about higher education, actually. And John, our conversation partner here today, made an observation that might apply more widely.

Talking about tenure, here’s the quote. This comes from your time here, right? I’m going to quote you, John. “Let’s get rid of the entire legal structure of the nonprofit organization to start with.” That got our attention at The Giving Review. Then you said, and I’ll go to you then, you said “nonprofit status in the U.S. has been, like everything else, horribly misused. Now it’s a cover,” you said.

Why don’t we start there, John? For what might nonprofit status be a cover?

Cochrane: All sorts of things. It’s something that’s been long on my mind, so I’m delighted to learn of your efforts to put facts and figures to it, which I have been meaning to research, but haven’t.

Many nonprofits do good work, but even things organized as profit-making companies can do good work. The issue at hand is the tax and other protections for nonprofits. If you just look out the window, you can see that many nonprofits have been misused for political purposes. The nonprofit structure allows you to give money, tax-deductible, to organizations whose primary purpose is partisan political advocacy, buttressing political candidates from one side or another.

As a sort of libertarian-conservative, I see it mostly on the left. Even hallowed institutions like the ACLU have become places for anti-Trump hysteria and partisan political advocacy, as opposed to defending civil liberties.

It is also a massive tax dodge. Why does every celebrity have a nonprofit organization? Well, if you die, you’re going to give about half of your money to the federal government unless you’re really careful. One way of being real careful is to put the money in a nonprofit, in quotes. A nonprofit has to give some money away to charitable causes, but it can employ all of your relatives and no-good children and grandchildren, aunts and uncles, and friends and cronies at high salaries, pay for their executive-jet travel.

They have also become political slush funds. The Clinton Foundation is a good example, though they exist on both sides of the political aisle. You have Hillary Clinton come give a $500,000, 20-minute speech, which you deduct from your taxes, or give them a big gift. That goes to the foundation, and the foundation supports her army of helpers when out of office. It’s a subsidized, tax-financed, political-advocacy and slush fund for political characters.

Protection from competition is an unrecognized feature of nonprofits. Suppose a university is being badly run and is stuffed with too many administrators, faculty giving useless classes, and the whole thing is politicized. If a private business is badly run like that, you can buy up the shares, fire the management, restructure it, and make it competitive. Being a non-profit insulates the business from what we call in finance the “market for corporate control.” It’s very much easier to insulate wildly overpaid management and staff.

Universities are basically a tax-free and tax-subsidized hedge fund. They borrow money at tax-free rates, investing it in high-fee managed assets, with no taxes on the return, run a football team, teach a few classes and pay immense salaries to staff and an army of administrators. Well, you can’t take that over the way you could a private business.

Hospitals are increasingly nonprofit, as well, which allows them to remain uncompetitive. I could go on, but I’m taking too long here.

Freedom and Taxes

Hartmann: Some might say that your proposal, mentioned in passing, or others that we could talk about short of that, would infringe on philanthropic freedom. How dare you even suggest so. Do you see such a proposal as an infringement like that? What would you say to even a conservative critic of such a thought?

Cochrane: There’s a difference between freedom and tax deduction. Thank you for mentioning that. In my world, you will be perfectly free to give to any cause you want as you are now perfectly free to give to a political candidate, which is not tax-deductible. We just aren’t going to subsidize your freedom to give to particular things or other things.

I’m surprised you’re still employed for saying this! Me, too—I’m joking. Hoover is really strong on academic freedom, even to talk about ending nonprofit status. Both of our institutions live off of philanthropic donations. The standard argument is, we need to encourage philanthropy—to which I would say two things. One, I hope that in the new world, genuine philanthropy will survive by substitution. If you don’t have a tax dodge, getting around the estate tax, or subsidizing your political causes, you will then give the money you’re going to give to things that are genuinely doing good in the world. And I think our institutions are.

The rest of the world does not have this system, by the way. Philanthropy exists when it’s not supported by taxes.

The other thing I’d mention is—I want to appeal to progressives here—it is horribly regressive to give tax deductions for charitable donations. It means the preferences of rich people—let me be more progressive: rich white people—[are] what get a tax benefit.

Imagine the government said that for every dollar we—well-off, middle-aged, rich, white people—give, the  federal, state, and local government put together, will tax everybody else and write a check for 50 to 60 cents to the causes we choose to pick. But poor people, minority people, no, if they give, no matching tax money. There would be riots in the streets. The inequality, the injustice. That is exactly what the tax deduction for charitable contributions does.

Hartmann: Maybe there’s an alliance that could be pursued over the next, well, whatever it would take, 20 to 30 years about this.

Cochrane: I thnk that’s right. Dick Thaler at Chicago is a regular intellectual antagonist of mine, but this is a point he has made and quite forcefully, too. If you’re honestly worried about redistribution, this idea—not just that we’re going to redistribute money from poor to rich, but we’re going to have the system of philanthropy and charity aligned with the preferences of a few extraordinarily rich white people—is shocking.

Hartmann: Pursuing the thought experiment, there would be more LLCs engaged in philanthropy, right? There are some examples of that. They might be mostly progressive ones arising out of Silicon Valley, but they would be LLCs doing their giving and paying what I’ll call full freight, full tax freight, for what it is they want to give to. Is that right? I mean, you want to LLC-ize, which would be something familiar to many in philanthropy, all of giving. Do I have that right? Is that what this would be?

Cochrane: Yes. Lots of organizational forms could work. You can just write checks if you want, without worrying about the tax consequences of it. Yes, you could structure a philanthropic organization. It could be a corporation or it could be an LLC or it could be a partnership. In my world, we’re going to get rid of the corporate tax entirely. That’s another issue.

Hartmann: You want to get rid of a lot ….

Cochrane: We don’t have to tie this proposal to that one. Also, by the way, nonprofits don’t pay property taxes. If you’re going to have huge sprawling grounds and beautiful stadiums, you’re going to start paying property taxes on that stuff and thereby help the communities in which you live to finance things.

By the way, the company won’t necessarily have to pay taxes, because it doesn’t have to make money. If you organize an LLC for the giving away of money, that LLC doesn’t make any money, so won’t have any corporate tax liability. It’ll have property-tax liability and it will pay taxes on its employees like everyone else does.

The Right Answer and the Possible

Hartmann: So the contemplated solution you mentioned in passing there is quite, I’ll say, efficient. Some might propose other things, including one that would be responsive to your first critique. Why not just better define in the law what’s charity and what’s politics? Might that work? There have been previous attempts, there’s not a record of success, but is it the case that the solution has to be as efficient as yours—getting rid of the whole artifice, the whole structure, as it were—or could one maybe tinker with definitions of politics and charity, and this, that, and the other? That’s been proposed.

Cochrane: Certainly, one could. I think it’s useful in our public-policy debates to start with, what is the right answer? Because we all too often, we say, well, we can’t possibly do that. So let’s start tinkering with the politically possible, and there’s a Senator from Iowa who will vote against this, so we have to blah blah blah blah blah. That’s, in the end, how stuff gets done. But if we never state the desirable thing, the perfect or right answer, we’ll never get there. And what’s politically possible can change very fast. Also, economists shouldn’t pretend to be politicians and know what is and is not possible.

But of course, yes, we could easily do partial reforms in lots of ways. One of them is to really be much more sticklers about political activity for charitable things. Now, the problem is that we live a democracy. Watch the tax code: democracies are responsive to their constituents, especially wealthy constituents who go to Washington armed with all sorts of requests for things. The tax code becomes an obscenity quickly, as the nonprofit code has.

Of course, especially where I live—I’m more attuned to lefty stuff because I live in California—our plutocratic progressive techies want very much to give gazillions of dollars, and they want to fly to Washington and get tax deductions for it, because they like tax deductions. That pressure will be inevitable and America is very partisan and political. Take unions as a good example. The purpose of government-employee unions is to take money from people and force it into, currently, Democratic Party politics.

So the political force for tax deductions, given to “charities” that are mostly political and especially progressive, is going to be strong. We can’t get together and reform most basic, obvious things like the Jones Act. Every university president will be out screaming how this is the end of higher education and opportunity in America if we get rid of nonprofit status and tax deductibility of charitable donations. Every wealthy donor will too.

Part of the problem is we love to have this pretense of very high tax rates that rich people don’t actually pay. We like to say, we’re the great redistribution, social-justice America. Our tax code has at least a 70 percent marginal tax rate on high incomes, but people don’t want to actually pay 70 percent. So we hide the actual tax rate in the weeds. I think politically, getting people to give up that tax break would have to come with what we all know we also need—a widening of the base, immense simplification of the tax code, and lowering of the marginal rates. Then we get rid of the pretense of astronomical taxes on “the rich.”

Yes, I think anything we could do on the margin would be good, and I think there might be bipartisan ways of doing that. Unfortunately, right now, most of the tax deduction, in my view, benefits progressive causes. It’s kind of funny that the progressives are all worried about the Koch Foundation and right-wing money in politics. All the money in politics is cloyingly left wing. When actually facing the reality of losing their subsidized base, it’ll will be very hard to get genuine reform.

Hartmann: Unless you have anything you might want to add, John, why don’t we end the conversation there? Thanks so much.

Cochrane: Thank you. Keep up the good work.

 

This article first appeared in the Giving Review on April 12, 2021.

Michael E. Hartmann

Michael E. Hartmann is CRC’s senior fellow and director of the Center for Strategic Giving, providing analysis of and commentary about philanthropy and giving. He…
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