During the past year, as philanthropy accelerated efforts to address racial injustice and longstanding disparities laid bare by Covid-19, many of us took a hard and occasionally uncomfortable look at what needed to change within our own organizations. Some people in the nonprofit world also called for legal and regulatory changes they say will create a more equitable society, including increasing to 10 percent over the next few years the federal requirement that now says foundations must distribute at least 5 percent of their assets annually.
While philanthropy absolutely must continue to mobilize resources for Covid-19 relief and to address systemic racial inequity, requiring foundations to distribute more of their assets is not the right solution. In fact, a recent study commissioned by my organization, the Council of Michigan Foundations, found that such an approach is unnecessary and fails to follow the data. In the long run, it may even entrench the very inequities that advocates hope to reverse.
The experience of some of the largest foundations in the Midwest show why a long-term commitment to addressing inequity is critical — and why higher payout mandates aren’t necessary or helpful. These organizations were built on the bequests of early U.S. industrialists, including those who built automobile manufacturing, lumber, and mining fortunes. Michigan is fortunate to have founders named Kellogg, Kresge, and Mott who created their foundations to operate in perpetuity — or forever. This ensured that grants would always be available to support the needs of changing communities and help navigate the boom-and-bust patterns characteristic of cyclical industries.
The model is working. For example, it enabled the Charles Stewart Mott Foundation and the Community Foundation of Greater Flint to provide support to begin repairs on the Flint water system quickly and to establish a long-term relief fund for families suffering adverse effects from the water crisis.
Five years earlier, a coalition of local foundations worked together to help the financially strapped city of Detroit emerge from its 2014 bankruptcy in just 16 months. Those 13 foundations were able to support the Detroit solvency effort because they had the resources to deploy in case of emergency. Had a higher payout mandate been in effect a decade ago, that might not have been the case.
For instance, our study found that a temporary three-year mandate to disburse 10 percent of assets could lower endowments so sharply that foundations might take 20 years to recover. Researchers reached this conclusion by exploring whether changing financial markets, including historically low interest rates and growing philanthropic assets, could support an increase in the 5 percent payout rule for private foundations. The answer was an unequivocal no.
Giving More Than Required
The argument for increasing payout rates hinges on the assumption that foundations treat the 5 percent standard as a ceiling — not a floor. The data show this simply isn’t true. Nearly half (49 percent) of Michigan foundations disburse 6 percent or more of their assets each year, and more than a third (39 percent) pay out more than 9 percent. These rates are consistent with national trends.
For the more than 10 percent of foundations planning to spend all their assets and shut down in a set time, reducing endowment size in this way may be desirable. However, for foundations built to give in perpetuity, a higher mandatory payout could be disastrous, risking shortfalls that would leave them unable to continue deep support for nonprofits in their community and powerless to respond adequately to unanticipated crises.
Current rules allow founding donors to choose whether they want their philanthropies to live forever, a decision often based on the kinds of problems their bequests aim to solve. This flexibility is an extraordinary gift, providing space for organizations as diverse as the recently dissolved Atlantic Philanthropies to operate alongside many foundations that continue to address critical needs while operating forever. Eliminating this flexibility would damage foundations and the communities we serve.
Exacerbating Inequality
Moreover, the argument that higher payouts will inherently promote equity does not survive even superficial scrutiny. If a foundation lacks an authentic awareness or commitment to diversity and inclusion and uses its grant making in ways that entrench existing inequities, whether accidentally or intentionally, increasing payout will only exacerbate the problem.
For foundations to meaningfully promote equity, they must take an honest look at themselves and their grant-making strategies. This includes listening to and joining forces with grassroots groups, especially nonprofits led by people of color, focusing grant making on projects and organizations seeking systemic change, and engaging in anti-racism work.
Self-regulation and the adoption of equitable practices are the most effective ways to ensure the integrity of our work. In some circumstances, of course, regulations are needed to prevent abuse and make sure that philanthropic organizations operate efficiently and ethically. Donor-advised funds are a case in point. When used as intended, DAFs can help donors better manage their charitable giving, but DAFs can also be abused in ways that enable tax-evading wealth parking and fail to advance a legitimate charitable cause.
To prevent this kind of abuse, the Community Foundations National Standards Board recently added a DAF activity policy as a requirement for accreditation. Among other rules, it requires that these funds make significant annual grants or actively plan for near-term grant making. If they become inactive, the standards require that community foundations holding DAF assets disburse funds for charitable purposes.
To help community foundations in our state implement these new rules, the Council of Michigan Foundations developed model grant agreements that can be adopted when establishing new DAFs. More than 75 percent of Michigan community foundations are now in compliance, and we are working to increase that number in the years ahead.
These policies are important, but on their own will not achieve the equity goals rightfully sought by philanthropic leaders. Results will only come from honest commitment and intensive effort. IRS regulations cannot and should not do the hard work for us.
