Nonprofits in the United States are designed to serve the public good and therefore don’t pay taxes — right? Wrong. While charitable organizations are exempt from paying federal income taxes and most state sales, property, and income taxes, they are subject to the same payroll taxes as companies such as Amazon and Apple.

That’s right — a nine-person after-school nonprofit in Kentucky pays the same 15.3 percent payroll tax per employee as ExxonMobil. Half of that tax is taken out of employee paychecks, further diminishing nonprofit wages. Information on nonprofit wages is not tracked regularly, but the most recent data from the Bureau of Labor Statistics shows nonprofit employees earn $10,000 less on average than their for-profit counterparts.

This is harmful to nonprofits, which can’t compete with the compensation offered by their corporate counterparts — especially in today’s tight labor market. It also puts them at a further disadvantage when economic challenges, such as inflation arise. While businesses, such as car dealerships, can use inflation to justify price increases, nonprofits can’t tell the same story to the families they support with donations of food and the sick they help heal.

The current payroll-tax system undermines and undervalues charities, which contribute to the economy and society at large. Beyond employing more than 10 percent of the work force and making up about 6 percent of the GDP, nonprofits encourage economic activity and often create work opportunities elsewhere in the economy. A nonprofit child-care center, for example, allows parents to work outside the home.

As with other nonprofit-taxation policies, the payroll tax should be used to boost rather than penalize nonprofits and the workers who fuel them. Fortunately, there is a simple solution: structuring the payroll tax more like the progressive income tax.

Because the United States and many states recognize that millionaires and billionaires can pay a larger share of their income on taxes, their incomes are taxed at higher rates. The federal progressive income tax has seven brackets ranging from 10 percent for incomes under $9,950 to 37 percent for incomes of more than $523,000. The federal payroll tax, by comparison, has one flat rate for all employees regardless of income and the type of organization they work for.

240,000 Charities Could Benefit

If a similar progressive-tax approach were taken with the payroll tax, it could help balance the tax burden on small nonprofits. For a total cost of $3.7 billion, the United States could remove payroll taxes for nonprofit organizations with fewer than 100 employees and less than $5 million in annual revenue. Based on data I analyzed from the nonprofit data aggregator CauseIQ, this would benefit roughly 240,000 organizations that serve the public good and employ 2 million people.

This proposal also has the potential to attract bipartisan support since it would help small nonprofits of all ideological stripes, including conservative religious groups and progressive activist organizations.

In fact, there is precedent in Congress for this type of a payroll-tax adjustment. The Employee Retention Credit, created by the CARES Act, was effectively a credit against payroll taxes aimed at helping businesses and nonprofits keep workers on their payroll during the pandemic. But it was retroactively revoked late last year. Ben Kershaw, director of public policy and government relations at Independent Sector, says his group has been working to restore the credit and supports any solution of this kind that “puts more resources toward charitable missions nationwide.”

Limiting the benefit to small nonprofits would help avoid opening a tax loophole that might result in large corporations trying to save on payroll taxes by moving parts of their staff to sister nonprofits, such as the social-impact entities of Alphabet (Google.org) and Walmart (Walmart.org). A benefit ceiling would also exclude universities, hospitals, and other large nonprofits, which are doing fine in comparison to small charities that don’t charge fees for their services.

This policy would laser focus a $3.7 billion annual stimulus on a core group of nonprofit organizations doing the essential work of rebuilding our country as it emerges from the pandemic and continuing economic challenges.

Consider that in 2020, the federal government spent $349 billion to help small businesses through the Paycheck Protect Program and billions more in other Covid-19 relief. While some billion-dollar businesses bilked the system by creating smaller entities to receive the loans, nonprofits used these resources to cover direct service costs and retain employees. Nonprofits, after all, are held accountable for increasing societal value — not shareholder value. A progressive nonprofit payroll tax would reward those priorities on a continuing basis.

Tap Corporate Tax Dodgers

Where might this money come from? The opposite side of the market: companies with more than $1 billion in revenue that leverage an array of tactics to avoid paying federal taxes. Amazon, for example, paid a federal tax rate of just 1.2 percent in 2019 through a sophisticated series of carryover losses, tax credits, and stock-based employee compensation. A progressive policy that increased the payroll tax for these large corporations by just 0.5 percent would more than cover the cost of eliminating the tax for small nonprofits.

Is that a realistic proposal given the political resistance to corporate taxes? The simple answer: There has never been a better time to try.

During a period of pandemics, inflation, labor shortages, and war, the benefit to the public good is clear. This type of targeted stimulus would be a strong signal that our nation supports the critical work nonprofits perform every day — now and in the years to come.