Playing the Percentages

New study heats up the debate over how much of their assets foundations can–or should–give away each year

A new report by a Barnard College economist contends that foundations have not been giving enough away over the past two decades to merit the tax benefits they and their donors receive.

Perry Mehrling, chairman of Barnard College’s economics department at Columbia University, says his analysis of giving patterns found that foundation grants have not kept pace with the growth in

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grant makers’ assets. Since 1981, he notes, the value of foundation assets in America has tripled — largely because of the creation of new philanthropies. However, the percentage of assets that foundations distributed to charity declined from 7.9 per cent in 1981 to 4.8 per cent in 1997.

“We’re not getting the bang from the buck that Congress and society has a right to expect,” Mr. Mehrling says. “We’re giving big tax advantages to these foundations and I’m not sure we’re getting good value from it.”

Mr. Mehrling’s analysis was commissioned by the National Network of Grantmakers, an organization that is pushing foundations to increase the amount they give away annually. By law, foundations must distribute at least 5 per cent of their investment assets each year — though they are allowed to average that amount over several years.

Mr. Mehrling’s report has been criticized not only for its conclusions but for the methodology he used in his study. Some grant-making experts contend that his approach was biased to make it seem that foundations were stingier than they are — and to make the case that Congress should increase the minimum payout standard — charges that Mr. Mehrling strongly rejects.

In a report on his study, “Spending Policies for Foundations: the Case for Increased Grants Payout,” Mr. Mehrling takes aim at an argument commonly made by grant makers: that if all foundations were required by law to distribute more than 5 per cent annually, many would be forced to shut down in a generation or so, and as a result there wouldn’t be sufficient philanthropic resources to deal with the problems of the future.

Instead, Mr. Mehrling contends a typical foundation could have given away up to 8 per cent of its assets during the past 20 years without significantly decreasing the value of its endowment.

While a few foundations would probably go out of business if they distributed as much as 8 per cent annually, he conceded, recent history suggests that other foundations would be established or expanded to insure that money is always available to finance charitable projects.

Mr. Mehrling’s analysis was based on data collected from 44,000 foundations by the Foundation Center, in New York.

But officials at the center — and other grant-making experts — are raising questions about whether the data were analyzed in ways that led to sound conclusions.

They say Mr. Mehrling should have limited his analysis to private foundations, instead of looking at asset growth and giving patterns at all kinds of foundations — such as community and operating funds, which are not covered by the federal 5-per-cent payout rule.

What’s more, they argue that Mr. Mehrling applied too strict a standard in figuring out how much foundations were distributing annually. He counted only grants, but foundation leaders say he should have included other expenses that foundations are legally allowed to count when they calculate whether they meet the 5-per-cent payout standard. Such expenses include administrative costs and trustee compensation.

“The methodology amplifies the effect that the report is chasing after,” says Peter Frumkin, an assistant professor of public policy at Harvard University’s John F. Kennedy School of Government. “This study is not necessarily about deriving the definitive policy analysis of this issue, but more aimed at generating a political conversation.”

But Mr. Mehrling denies his approach was biased. He says his analysis had nothing to do with ideology but was based on the standards that economists always use to determine the social benefit of public policies.

“Society does not care how much foundations are spending on their rent, or how much they are giving to their top executives,” he says. “What is in the social interest is actual charitable giving. I’m trying to get a sense of how much society is getting for the tax advantage they provided this sector.”

Mr. Mehrling says he was forced to include all foundations in his analysis — not just those covered by the 5-per-cent rule — because the Foundation Center did not have data for the years before 1989 that separated out different kinds of grant-making organizations. He said he felt it was important to look back at least as far as 1981, when Congress revised the payout formula to require the 5-per-cent annual distribution.

He says including other types of foundations didn’t skew the results, since private foundations accounted for about 85 per cent of the total assets and 75 per cent of the total grants made by the foundations in the sample.

However, he did look specifically at the giving trends of private foundations for the years when such data were available. For instance, in 1997, he said, those funds distributed 4.38 per cent of their assets in grants.

Foundation Center officials say that they don’t consider that figure to be accurate. They estimate that in 1997 private foundations distributed 5.46 per cent of their assets in grants. The discrepancy is based on different methods of measuring the percentage given away.

The Foundation Center, following the policy of many grant makers and an approach that is allowed by the Internal Revenue Service, calculates the payout rate by dividing the amount distributed in one year by the value of a fund’s assets in the previous year.

Mr. Mehrling, on the other hand, divided giving by asset values in the same year. He says that the Foundation Center approach would show payout to be a bit higher in some years, but that it would not change the overall downward trend in the percentage of assets foundations have given away.

The National Network of Grantmakers commissioned Mr. Mehrling’s report as part of its “1% More For Democracy” campaign, which encourages foundations to increase by one percentage point the share of assets they give away each year and to dedicate those dollars to progressive causes (The Chronicle, September 23).

Robert McKay, president of his family’s McKay Foundation, in San Francisco, and a member of the network’s payout committee, says that the Mehrling report makes the case that “if anything, a one-percentage-point increase is not only doable but is actually incumbent on the philanthropic community to think seriously about.”

He adds: “I do not think there is any question that we do not endanger foundation endowments, and by virtue their life cycles, by talking about a one-percentage-point increase.”

But many foundation leaders disagree.

Officials at the Robert Wood Johnson Foundation, in Princeton, N.J., have calculated how their own assets would be affected by increases in the payout requirement.

It made separate calculations based on the requirement staying as it is, rising to 6 per cent or 7 per cent, and then figured out what would happen if its investments fared very well, moderately, or poorly. They found that in each case, for about the next 20 years charities would overall receive more at the 6-per-cent and 7-per-cent payout rates. But after that, the total given to charities would drop significantly because the foundation would have a lot less money available to spend than it would have had if it kept distributions consistently at 5 per cent.

Congress first imposed a payout minimum in 1969 when it passed a major tax bill designed to make foundations more accountable to the public and make sure that they weren’t hoarding their assets.

Initially, Congress voted to set the minimum payout at 6 per cent of a foundation’s investment assets or the entirety of their net investment income, whichever sum was greater. Seven years later, Congress lowered the rate to 5 per cent. In 1981, it dropped the idea of pegging the payout to net investment income but kept the 5-per-cent rule.

“Congress intended to keep tax-favored foundations from becoming mere warehouses of wealth,” Mr. Mehrling argues in the report.

But, he adds that, in setting the 5-per-cent payout, “what Congress did not anticipate was that new [foundation] gifts would be so strong.” He said that in the past two decades it has not been investment growth that has caused foundation assets to balloon so much, but the creation of new funds. He attributes 85 per cent of the rise in asset value to the start of new foundations — or the expansion of existing ones — and only 15 per cent to investment growth.

He said that if foundations try to give conservatively so they can continue to invest a large share of their endowments to generate new grant funds, “they defeat the real social purpose of their privileged tax status and risk attracting renewed legislative attention.”

He says that foundations are not serving society by insisting that they deserve the freedom to exist forever. Such arguments, he says, are “equivalent to saying that society has reason to preserve the Chrysler car company in perpetuity.”

He adds: “No doubt donors want to create perpetual monuments to themselves, but why should society help them for that in terms of tax laws?”

But some grant makers disagree, and think that it would be wrong for the government to increase payout requirements — and, in effect, make it impossible for a donor to set up a foundation that he or she could be certain would operate in perpetuity.

“If you believe that foundations should honor donor intent to be around in perpetuity, then the premise of the report is flawed,” says Rebecca Rimel, president of the Pew Charitable Trusts, in Philadelphia.

Copies of “Spending Policies for Foundations: the Case for Increased Grants Payout,” are available from Julio C. Rosa, National Network of Grantmakers, 1717 Kettner Boulevard, Suite 110, San Diego 92101; (619) 231-1348; or through the organization’s Web site, http://www.nng.org. The cost is $8 prepaid, plus tax and a shipping and handling fee.