February 24, 2013

Plethora of Charities Breeds Confusion and Stretches Limited Funds

The American charitable system is the most open, most freewheeling, and in many ways the most democratic in the world.

Given that the Internal Revenue Service approves approximately 99.8 percent of all applications from people who want to start charities, it would seem that all it takes to start a nonprofit is a small filing fee, a modest ability to follow directions, and the patience to wait a brief period for official regulatory approval.

Once a group gets charity status, it loses it only by choice or because it faces an especially unusual or unfortunate event. Many charities are abandoned and a few are consolidated, but by and large, once a charity, always a charity. This is reflected in an extraordinary explosion in the number of charities in the United States, from 50,000 in 1950 to 367,000 in 1967 to 790,000 in 1977 and to about 1.1 million today.

This open system has benefits: It allows for new ideas, new blood, new causes, and new hope. But it also extracts a significant cost: The torrent of new and old charities creates confusion in the marketplace and stretches limited funds over too many organizations. As a result, even the most effective charities struggle to expand their services and tackle large-scale social problems with large-scale resources. From 2007 to 2009, for example, during the biggest American recession in 50 years, the nationwide ranks of arts organizations swelled by more than 3,000—at a time when public participation in the arts was dropping and existing arts organizations had to fight for their piece of declining public support.

The growth of charities has generated another problem: confusion in the marketplace that can benefit the unscrupulous.

Some 60,000 nonprofits in the country have the word “veterans” in their names, and it takes more expertise than the average donor—and certainly the average recipient of a fundraising call at dinnertime—can muster to distinguish between the legitimate and the illegitimate, the effective and the ineffective.

As I conducted research for a book about charities I have just published, I soon realized that one clear path to riches is to set up a new veterans charity, an associated and favorably compensated for-profit phone-banking company, and a great boiler-room operation. The confusion in the marketplace, the lack of adequate and transparent information, the absence of effective oversight, and the opaqueness of the law would make my unfortunate plan not even illegal, or at least not plainly so.

This is not a new issue. As far back as 1969, Sen. Al Gore Sr., Democrat of Tennessee (father of the man who served as vice president of the United States) was voicing these same concerns.

He did this in the context of a proposal to force all foundations to close within at least 40 years of their creation, but his words were a warning to the entire philanthropic world: “We are subsidizing bogus, phony charities. ... Once an organization has achieved tax-exempt status, no federal agency is adequately equipped for regulation, supervision, record keeping or knowledge of what happens. Under our present law, the organization enjoys that status forever.”

Such situations develop in part because governments at the local and state levels lack the resources they need to crack down on fraud.

The tax-exempt division at the IRS is chronically short staffed and barely capable of keeping up with the daily influx of new charity applications. Over the last three decades, its volume of responsibility has grown, a function not only of ever more applicants and charities but of increased (though still inadequate) reporting and informational requirements that the federal government has imposed on charities.

With the IRS pressed just to keep up with paper flow, we cannot expect it to do a meaningful number of reviews and investigations.

But simply because of the IRS’s existence, the federal government is doing better at cracking down on fraud than the states. Only a handful of states have active charity-regulation offices, and even those tend to be short staffed and largely inert. As Harvey Dale, a law professor at New York University and one of the nation’s foremost experts on charity regulation, has written, “In most states, the Charity Bureau of the Attorney General’s office is inactive, ineffective, understaffed, overwhelmed, or some combination of these.”

It is self-evident that the IRS and state governments should be strengthening their ability to enforce and regulate, both as a matter of law enforcement and as a matter of revenue collection.

But beyond that, we should be thinking about the underlying principles and whether they need to be reassessed in a time of changing market dynamics, changing needs, and changing expectations.

It may be time to reconsider the open approach the IRS takes to allowing charities to get off the ground and replacing it with a new more dynamic and competitive approach.

So why not start making it more challenging to start a nonprofit? Perhaps we should increase the filing fee ($5,000 is a commonly proposed figure) to assure that the charity has some solidity, some support, and a commitment beyond the preparation of legal paper.

But that alone is not enough.

To foster real change, we need to figure out a way to make sure that the charitable license is not a lifetime grant of immunity.

Whether we are talking about self-regulation, requiring nonprofits to live a limited life span by law, or accreditation systems, we should be thinking about new ways to support creative destruction.

A dynamic system requires not only new entrants but also new exits—organizations that go out of business when they can no longer keep up, generate new ideas, or prove the effectiveness of their efforts.

We should be conceiving of new structures like the British Charity Commission, for example, to provide oversight to an industry that now accounts for $1.5-trillion in revenue each year and more than 10 percent of our national work force.

The last year has shown some inklings of progress. Charity Navigator announced a new system, which for the first time, includes actual ratings of a nonprofit’s effectiveness, and the Office of Management and Budget issued new rules requiring federal agencies, starting in 2014, to strengthen measures to evaluate grant recipients. It is efforts like this, in support of the top-performing charities, and other incentives for nonprofits to be more transparent, accountable, and results-oriented, that will transform organizations not known for any of that.

In the end, a system that distinguishes among charities can emerge only in a marketplace that values measurement.

In the short term, such a concept may be deeply unwelcome within the nonprofit world. It promises many things that incumbent businesses wish to avoid: more competition, more accountability, and a system that will produce more winners and losers. All these things are contrary to the prevailing norms within the nonprofit world and unlikely to be warmly embraced.

But in the long term, reform will produce better results for people who use charitable services, reward performance, promote solutions on a broad scale, and craft a new compact with donors.

It promises a system that works for innovators in serving the common good—and for society as a whole.

Ken Stern, former chief executive of NPR, is author of With Charity for All: Why Charities Are Failing and a Better Way to Give, published this week by Doubleday.