The Coming Battle Between Nonprofits and Government

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In an economy where local governments are stretched to the financial breaking point, officials are looking for ways to boost tax revenue. Increasingly, one set of institutions that has largely gone unnoticed in the tax debate has become a high-profile target for tax hikes: nonprofit charitable institutions.

An August 2012 publication from the Urban Institute Center on Nonprofits and Philanthropy, which examined in detail the huge impact that large nonprofit institutions like universities and hospitals can have on the local community, makes the specter of taxation loom even larger.

Are nonprofits not paying their fair share?
As the Urban Institute paper notes, large nonprofits that are exempt from taxation present a huge challenge to municipalities. On one hand, they often represent a huge economic opportunity for a city or town, especially in small towns that rely almost exclusively on a college or hospital for their citizens' employment and income.

Yet those benefits don't come free. Having thousands of students can put a huge burden on traditional city services like police and utilities, yet when universities aren't subject to property taxes on the buildings and land they own, other town taxpayers can get left footing the bill.

The issue isn't limited to small towns. Philadelphia has more than 10% of its total property value owned by nonprofits, while a host of other cities, including Boston, New York City, and Denver, weigh in at more than 5%. With so much of their tax bases exempt from property tax, these cities face challenges to stay in healthy financial condition.

Moreover, some argue that nonprofits have an unfair advantage over for-profit businesses providing similar services. For instance, Apollo Group (Nasdaq: APOL  ) , DeVry (NYSE: DV  ) , and other for-profit colleges don't automatically get the same tax exemption that most nonprofit institutions of higher learning enjoy. Similarly, many hospitals are nonprofit, putting for-profit health facility companies HCA (NYSE: HCA  ) and Tenet Healthcare (NYSE: THC  ) at a competitive disadvantage.

Making a preemptive strike
One solution that is gaining popularity involves getting big nonprofits to pay local taxes voluntarily. With "payments in lieu of tax" or PILOTs, a nonprofit institution negotiates with a municipality to come up with reasonable compensation for the services the local government provides.

One problem with PILOTs is that they tend to involve one-off solutions to a particular problem rather than a comprehensive policy intended to cover nonprofits broadly. But in Massachusetts, where these arrangements are much more common, the city of Boston has had a PILOT program in place for more than 85 years that currently generates about $15 million a year in extra property tax revenue. Although that amount is less than 1% of the city budget, smaller towns like Bristol, R.I., and Lebanon, N.H., get a much larger share of their budgets covered by PILOTs.

Scrapping for cash
Even with innovative ideas like PILOTs, the tax-revenue shortfalls that local governments are facing aren't likely to go away anytime soon. Although cities and towns still get substantial support from state governments, the amount of money they receive from federal sources has fallen dramatically over time.

More recently, the bursting of the housing bubble has depressed property values, reducing tax bases considerably and contributing to local governments' revenue woes. Moreover, as governments scramble to try to fight unemployment, the packages they put together for large employers to attract them to build factories or other facilities in their areas often include tax incentives that lead to reductions in property tax revenue for the localities involved. For instance, a proposed Royal Dutch Shell (NYSE: RDS-A  ) plant could cost one western Pennsylvania town about 7% of its annual budget due to lost property tax revenue. Similar enticements have gotten increasingly competitive given high unemployment levels.

The result has been increased tension about local government finances. As bankruptcy filings in California for Stockton, Mammoth Lakes, and San Bernardino raise fears that they could be just the tip of the iceberg for a broader jump in municipal bankruptcies nationwide, it's clear that cities and towns can't afford to leave any potential vehicle for tax revenue untouched.

Touching the untouchables
In many areas, it would've been unheard of even to consider taxing charities. But as some of the biggest players in many local economies, tax-exempt nonprofits need to consider whether the benefits they give local townspeople truly outweigh the costs. If not, then voluntarily making payments in lieu of tax may be the best solution for everyone.

Whenever government gets involved with a problem, election politics come into play. Find out which companies could skyrocket after the 2012 presidential election in our latest special report from The Motley Fool. It's free and will point you in the right direction for big gains.  

Fool contributor Dan Caplinger supports charities as long as they're being charitable. You can follow him on Twitter @DanCaplinger. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy is our gift to you.

Read/Post Comments (2) | Recommend This Article (3)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 06, 2012, at 7:48 PM, aptosjoe wrote:

    Well one idea would be for local governments to pick up the cost of the services provided by non-profits. Oh wait! That's right, NPs do it cheaper and better.

    Sounds like they may be giving more than their fair share already.

    I'm told that Germany has a church tax and ministers are paid by the State. You pay the tax whether you partake of the services or not.

    In our system we contribute to charity only if we appreciate what the charity does. If they are taxed if will come out of contributions so some of us, the more responsible of us, will end up funding shortfalls in city budgets. If I wanted to make a voluntary contribution I'ld write a check. Sneaking in the back door by taxing the charities we give to is just another way to screw taxpayers.

  • Report this Comment On September 07, 2012, at 11:46 AM, DLThompson wrote:

    Dan states a truth: "tax-exempt nonprofits need to consider whether the benefits they give local townspeople truly outweigh the costs." The problem with the article though is that nonprofits do that every day. And that is the key point I made in the Urban Institute paper that Dan cites approvingly. Charitable nonprofits aren't given tax exemption because they are nice people. They earn it by being dedicated to the public good - alas, no return for Motley Fool investors - and by giving up their rights to profits, privacy, and politics.

    But as for competing with businesses, we need to remember that hospitals and colleges were all nonprofits originally. Lately, smart business people have figured out how to turn a profit in the same fields.That doesn't mean that the long-standing model has changed, only that some people playing by the rules have learned how to turn a profit. Nothing wrong with that; but there is something wrong with trying to undermine institutions dedicated to their communities in order to help others turn a profit. I hope that is not what is going on here.

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