For-Profit Charities

The recent Red Cross scandal is a reminder that charitable nonprofit organizations sometimes act poorly.  Meanwhile, many for-profit commercial organizations try to do good—by helping poor coffee growers, or providing hurricane relief, or supporting schools.  Yet the good-doing nonprofits enjoy tax benefits denied to the good-doing for-profits.  Why should this be the case?  It turns out that there is no reason for discriminating against commercial operations that provide charitable benefits.  Indeed, the incentive structures of a profit-making business could be used to enhance the efficiency of charities.  Hence the case for the “for-profit charity.”  Click here for the argument (an abstract of the paper is below).

Abstract:     
Nonprofit firms may not distribute profits to owners but instead must retain them or reinvest them. Nonprofits that are “charitable organizations” under Section 501(c)(3) of the tax code may receive donations from individuals who are allowed to deduct their donations from their income for tax purposes. We argue that the law should not link tax benefits to corporate form in this way. There may be good arguments for recognizing the nonprofit form and good arguments for providing tax subsidies to charities or donors to charities, but there is no good argument for making those tax subsidies available only to charities that adopt the nonprofit form. Consequently, the “for-profit charity” may well be a desirable institution. Currently, no such entity exists, but the reason is surely discriminatory tax treatment; the charitable activities of many commercial firms suggest that in the absence of discriminatory tax treatment for-profit charities would flourish. Current tax benefits for charitable nonprofits should be extended to for-profit charities, and to the charitable activities of for-profit commercial firms.

Comments

[TJ]

Very interesting paper. I get most of what you are saying, and the idea is certainly very thought provoking. I am, however, not quite convinced by your critique of the agency theory justification for limiting tax breaks to the non-profit firm.

The agency theory, of course, rests on the premise that because a consumer cannot effectively ensure the agent (the charity) will use the donated funds for a particular purpose (e.g. spend 80% of the money on poor children in Africa), we reduce the incentive of the agent to cheat by reducing the personal payoff to the agent in doing so, i.e. by making sure the agent can only pay himself in low-value perks instead of the full value. To be sure, this is imperfect, since a purely selfish agent would still prefer taking perks over taking nothing at all. But I think your view that the non-profit mechanism is entirely ineffective against non-altruistic entrepreneurs is too pessimistic. To achieve the same level of satisfaction, the agent in the non-profit must embezzel more funds than in the for-profit. This difference may be signficinat, because although there is information asymmetry between the charity and the consumer, the charity must at least make a pretense of producing a passable product. The market for chartiable donations is still somewhat competitive, and some brands (e.g. the Red Cross, the Salvation Army) attract more funding because they have a reputation for producing a high-quality product.

Your other suggestion is that we can effectively recreate the incentives of the non-profit form by contract, yet still keep the potential administrative effecicies of the for-profit form.

But reading the two forms that you propose, I don't see either really having any actual advantage over a non-profit form in the administrative costs savings which seems to be the best justification to allowing for-profit frims. Having the agent on a fixed-wage contract really places them in the same position as a non-profit and effectively removes the administrative cost saving justification. I concede that your entrepreneur hiring a manger model might work in this regard because the entrepreneur may have an incentive to hire the best manager possible ex ante to save administrative costs, but that just shifts the agency problem from consumers to the entrepreneur, and is the entrepreneur really that much better at preventing shirking than the market?

I like the innovation regarding an outside auditor as an additional layer of protection against abuse (but then a non-profit could do this too).

[Bob]

You would have to define "charity." I could prove the case that giving someone a job is charity, especially if I pay him $1.00 more than the average.

A better idea would be to exempt all corporations from paying income taxes. When corporations get taxed, we are really just taxing shareholders and consumers. Shareholders are actually being taxed twice. In reality, corporations don't pay taxes, people do. Corporations just pass tax expenses on to the consumers. Taxes just increase the cost of corporate products and services. Corporations are nothing more than people coming together in cooperation to make business.

[curtisstrong]

Hmmm...

For profit charity, huh? Sounds like a business proposition. I suppose that such an company could actually flourish, but the problem I see isn´t entirely related to taxes. Rather, the problem I see is convincing people to contribute to a self-interested entity. If people feel like they´re contributing just so that some CEO can have a big house, then it´s going to be difficult to get them on board. Such a company would really have to show a strong product, and something that is not currently being covered sufficiently by some other non-profit entity. I haven´t read the entire paper yet, but judging from TJ´s comments above, it seems that there are some options presented to undermine this hypothetical CEO´s ability to get rich off of charitable donations (or at least to thwart the company from amassing too much money based on promises to engage in charitable work).

Yet, there may still be some advantages to allowing the company to pay its "agent" a substantial sum. First of all, an agent has a different option. That is, there is a self-interest in beginning an enterprise, as well as a desire to do some good. One doesn´t have to conform to the sainthood model of a non-profit organization. Second, I´m not sure how the paper deals with the issue of shareholders, but taking away monetary controls is certainly a way of attracting investors, and consequently, money...everybody wins.

As far as the tax issues go, I´m tenatively on board. I´m no federal accountant, so I´m not sure what the financial pro´s and con´s are from the government´s point of view to implement something like this, but it makes sense to allow charitable contributions to whomever one likes. Understandably, there is ample room for abuse, but some sort of implementation requiring these companies to show they´ve been following the rules could be thrown in.

Anyway, if I´ve misunderstood anything, someone let me know.

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[Noumenon]

Corporations are nothing more than people coming together in cooperation to make business.

And a mob is just a collection of people coming together to make trouble, a molecule is just atoms coming together to make a bond, and so on... you can't deny something its own reality by pointing out its component parts. At the very least a corporation is the people plus a structure to organize those people -- the difference between a pile of sugar and sugar crystallized into solid sugar cubes.

[Yale Klat]

I see a problem of an unclear distinction between what is charitable and what is profit seeking. Many ordinary businesses happen to have positive externalities, but I would not call them charitable. Now there is a clear distinction made by charitable form. I agree that some NFP activities that behave like FP forms should be taxed, like some hospitals. Some corporate undertakings, like those of Google and Branson, should not be taxed - but where to draw the line. How should we treat a church that sells bagels on a Sunday morning or a pet shop that draws in customers for free training sessions?