Volume 93

93 Va. L. Rev. Online 235
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In “The Case for For-Profit Charities,” Professors Malani and Posner urge an end to the coupling of certain tax benefits and the nonprofit corporate form.  Unlike many theoretical essays in taxation, they conclude with rather concrete policy proposals. As a first best option, they suggest that if the government is going to give tax advantages to community-benefit activities, then it should extend those advantages across corporate forms. For the weak of heart, they propose as a second best, less dramatic alternative that the IRS relax constraints on the ability of nonprofits’ managers to take incentive pay. Malani and Posner have failed, however, to make the affirmative case for their broad recommendation. The case for relaxing the constraints on incentive pay is stronger, though not, as I suggest below, without problems.

Malani and Posner intend their arguments to generalize to all community-benefit activities, whether charitable or commercial, and often speak generically about “tax breaks.” For purposes of this Response—and in keeping with the authors’ primary focus in their essay—I will limit my discussion to charitable firms and to the specific federal income tax benefit of the deduction for charitable contributions under Section 170 of the Internal Revenue Code. Malani and Posner conceive of the charitable firm as involving three parties: a donor, an entrepreneur, and a beneficiary. The charitable firm on this view is essentially a conduit, with the entrepreneur channeling funds from the donor to the beneficiary. Focusing on these parties and on the particular tax benefit of the charitable deduction for contributions to the firm, one can sharpen the authors’ policy proposals as follows: Their broad proposal would permit the deduction of contributions to firms even where the nondistribution constraint is relaxed with respect to entrepreneurs and donors.  The narrower proposal entails that contributions to firms should be deductible where the nondistribution constraint is relaxed with respect to entrepreneurs.

I consider these two proposals below, but as an initial matter I note that the current nonexistence of “for-profit charities” presents something of a puzzle for Malani and Posner. Their argument is one that sounds in efficiency. Tax differentials in the current system, they argue, prevent optimal incentives.  They are of the view that removing these distortions could yield substantial efficiency gains. Moreover, the authors claim that “for-profit charities” do not exist because of tax disadvantages (the chief disadvantage being the inability to receive deductible contributions). But this fails to acknowledge important nuances in the charitable deduction under Section 170. For decades that deduction has been capped. Currently, one may not deduct more than 50% of adjusted gross income.  Although it is extremely difficult to know how much donors contribute to nonprofit organizations in excess of the cap, it is commonly accepted that at least some donors do so. If the efficiency advantages that Malani and Posner claim for “for-profit charities” in fact have value, then one would expect a sorting of donors and contributions. That is, one would expect at least some contributions that are non-deductible in any event to flow to for-profit charities, in light of their supposed advantages. But the form essentially does not exist. Why? I think there are a couple of possible explanations for the puzzle, both of which run against the grain of the basic proposals in the Essay. One possibility is that the form of “for-profit charity” is problematic in terms of corporate law. It would be disfavored, that is, even if the tax law did not disadvantage it. Another possibility, of course, is that the efficiency gains are simply not to be had.

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