A Conversation with the Tax Foundation’s Scott Hodge (Part 1 of 2)

Scott Hodge has been one of the country’s leading experts on tax policy, the federal budget, and government spending for decades. From 2000 to 2022, he was president and chief executive officer of the respected Tax Foundation in Washington, D.C. He is now president emeritus and senior policy advisor.

His new book Taxocracy: What You Don’t Know About Taxes and How They Rule Your Daily Life comprehensively describes and analyzes the many ways in which taxes—separate and apart from merely raising money for the government—make us do things we wouldn’t normally do, as well as not do things we would normally do.

Taxocracy also includes an informative chapter on the effects of certain lack of taxes—exemption, by policy for certain purposes, from otherwise having to pay them. “Perhaps counterintuitively, there are times when not taxing something can distort the economy as much as taxing something,” Hodge begins the chapter.

“Don’t get me wrong: this is not an argument to tax everything,” he cautions. “It is a case for tax parity and what economists call tax neutrality.”

Hodge thus examines tax-exemption for charitable nonprofit organizations in both Taxocracy and, in more depth, an important and timely recent Tax Foundation paper, “Reigning in America’s $3.3 Trillion Tax-Exempt Economy.”

“For over a century, lawmakers have exempted politically favored organizations and industries from the tax code,” he writes in the paper. “As a result, the tax-exempt nonprofit economy now comprises 15 percent of GDP, spans more than 1.8 million organizations, and manages over $8 trillion in assets. In 2019, it pocketed more than $238 billion in net income.

“The tax-exempt sector is overdue for review and reform,” Hodge continues. “The U.S. needs a principled, rules-based approach to 1) distinguish between benevolent organizations and tax-exempt businesses, and 2) level the playing field between the business activities of nonprofit and for-profit entities.”

He recommends a “reasonable rewriting of the tax-exempt rules,” writing that it “should include narrowing the definition of ‘public charity’ and subjecting all non-charitable income to the corporate tax rate of 21 percent.”

The Philanthropy Roundtable’s director of policy research, Jack Salmon, responded to Hodge’s recommendations by writing that they “overlook the distinct mission-driven focus and reinvestment practices of nonprofits,” amounting to “[p]unishing American citizens by taxing their constitutionally protected right to freely associate.”

The even-tempered and good-natured Hodge was kind enough to join me for a recorded conversation last week. The just more than 15-minute video below is the first part of our discussion; the second is here. In the first part, we talk about the tax-exempt economy, narrowing the tax code’s definition of “public charity,” and subjecting supposedly charitable nonprofitdom to tax neutrality.

We’re seeing a very large increase in the “amount of business-like income that’s being generated by a lot of these large,” tax-exempt, nonprofit institutions, Hodge tells me, “whether they’re hospitals, universities credit unions, insurance companies, and so forth.

“This is undermining free enterprise,” he says, “when you have large nonprofit, non-taxed, or tax-exempt organizations competing directly with for-profit organizations. It really undermines free enterprise and I think that that’s a danger.”

“I just think that that’s completely unfair because these nonprofits are really competing from an advantage, a tax-subsidized advantage,” Hodge continues, “where taxpayers are effectively subsidizing them because of their non-for-profit status and their tax-exempt status, and that gives them a big leg up in competing with a lot of these for-profit companies.

“No for-profit organization or company should be forced to pay taxes in order to subsidize their competitor down the street. That’s really unfair,” he says.

On the other hand, no one really is against truly benevolent organizations, whether it’s the food bank, the women’s shelter, the homeless shelter, and so forth. There are truly benevolent organizations out there, but they’re shrinking in number and size compared to these much-larger organizations that are really businesses masquerading as nonprofits.

In his Tax Foundation paper, Hodge notes, he’s arguing that we should try to “build some rules of thumb that we could apply that draws those distinctions between the truly charitable organizations and the big businesses.”

Asked whether the current definition of “public charity” might also result in the indirect subsidization of political activities with which a taxpayer might disagree and would not directly fund otherwise, he says “a lot of nonprofits that get government grants are on the leftward side of the political spectrum” and

if you start looking at where some of those grants are going, they’re basically grassroots organizations for politically progressive organizations. This is walking-around money for the progressive left, giving them millions and millions of dollars in order to do door-knocking and other sorts of political activism. We see that across the board, in addition to whatever organizations that are out there and … engaging in somewhat political enterprises and hiding behind a nonprofit status.

In the conversation’s second part, Hodge discusses the broad way in which tax neutrality should be applied to charitable nonprofits’ business income, as well as the benefits to economic growth of doing so.

This article first appeared in the Giving Review on August 12, 2024.