For-Profit Philanthropy & Democracy

In recent years, philanthropic expenditure has sky-rocketed. However, in political philosophy, philanthropy and democracy are often understood to be in tension with one another. To explore this topic further, SDI Managing Director Dr. Roslyn Fuller recently spoke with Prof. Dana Brakman Reiser and Prof. Steven Dean about their book For-Profit Philanthropy: Elite Power and the Threat of Limited Liability Companies, Donor-Advised Funds, and Strategic Corporate Giving

Dana Brakman Reiser holds a chair as Centennial Professor of Law at Brooklyn Law School, where she also served as Vice Dean. She teaches courses in Corporations, Nonprofit Law, Social Enterprise, Property, and Trusts and Estates. A globally recognized expert in the law at the intersection of business and charity, her work on the law of social enterprises – firms that pursue profits for owners and social good – defined the field. She has also written extensively on law and finance for philanthropic organizations and on sustainable investing.

Steven Dean is Professor of Law and Paul Siskind Research Scholar at Boston University School of Law. His scholarship explores international tax policy, racial equity, and the intersection of tax law with philanthropy and social enterprise. He teaches courses including International Tax, Introduction to Federal Income Taxation, and Taxation and Racial Capitalism.

Below is the transcript of the interview between Dr. Fuller and Profs. Dean and Brakman Reiser

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RF: Professor Brakman Reiser, Professor Dean, thanks so much for taking the time to speak with me today about modern philanthropy and democracy. How did you come to focus your research on the law of philanthropy?

Brakman Reiser: I came to my interest very organically from having a lot of experiences working with non-profits in my upbringing and my college years. I also wrote my undergraduate thesis, in part, on the charitable deduction, so when I began my legal studies, I wanted to focus on that. As I began my teaching career, I was teaching about for-profit businesses, because you can't get a teaching job just teaching about non-profits, and I started to see so much of the interesting intersection between for-profit and non-profit activity, and that blurry boundary between charity and commerce, and so I started writing a lot of scholarship in that space, including on non-profit governance and finance. The current work I’m doing on for-profit philanthropy just fits into that general vision of my work.

Dean: For myself, there are two answers to that, and I'll start with the one that is mostly true, and get to the one that really is the most important. I'm a tax specialist, and tax is what drew me to law, so I'm very interested in questions of redistribution and equity. So, this is a natural extension of those things that I do in my tax universe.

But the most important fact is that I had an office just down the hall from Dana for many years, and we got drawn into working together on social enterprise. We wrote several articles and a couple of books about social enterprise and this was also an outgrowth of that. Because of my interest in tax and questions of equity and redistribution, it was really a natural fit for me.

RF: I think that's really interesting, because a lot of people who go into tax law, which is very demanding, spend a lot of time looking for ways to help their clients keep their money, rather than give it away. So, from tax to philanthropy might strike some as an unusual career path.

Dean: Yes, it is definitely true, and I've definitely done my time in Big Law. However, even though I have worked as a tax lawyer, my perspective is not the most traditional perspective. I just had another book come out – Racial Capitalism and International Tax Law: The Story of Global Jim Crow – which is about the way that anti-Black racism has shaped our global tax system.

RF: My interest in your work was piqued by a slightly earlier work you both co-authored: For-Profit Philanthropy: Elite Power, the Threat of Limited Liability Companies, Donor-Advised Funds, and Strategic Corporate Giving. I think what I'd like to focus on first is the term ‘for-profit philanthropy’, because I think it’s fair to say that the average person tends to think of philanthropy as an activity that involves giving money away, not making more of it. Could you unpack that a little bit and explain what for-profit philanthropy is?

Brakman Reiser: We intended the term to be provocative, but we also think that it's apt. What we're trying to describe in the book is the trend of players and practices and norms that are native to the for-profit sector, that are designed for business organizations that are seeking profit, having migrated into the philanthropic sector and that are now taking shape there. Particularly, because we are law professors, we are identifying in the book the ways that the law of philanthropy is not really equipped to manage that migration and still achieve the regulatory goals of philanthropy law. So, the examples that we use in the book are all examples of this pattern of migration.

RF: Would you say this change to practice has been caused by people coming from private business and saying, ‘I know how to solve problems, I’ve solved them in business and I'm going to apply these methods from the business world to these social problems?’

Brakman Reiser: Sometimes, absolutely. But sometimes it's much more tactical than that. It’s also people thinking, ‘When I run my business, part of what makes it really effective is that I can choose strategically among various types of business forms. And so I'm going to use that flexibility when I deploy my philanthropic resources’. Or ‘in my business activities, it's really valuable for me to not be as transparent as philanthropy regulation would expect me to be in my philanthropic activity, but there are benefits of not being transparent, even benefits to the very philanthropic goals that I have, and so if I can use those tools of business to obscure some information, because it doesn't gel with the expectations of the law, then I can achieve my objectives’.

So that generates a kind of threat – and that is what we captured in our attention-grabbing title, but it could also be used in ways that are philanthropically valuable.

We just noticed that there's so much being borrowed from for-profit business, not just in the kind of mindset of the players involved, but also in the tools that are being ported over and the norms that are at stake.

RF: An aspect you mention in your book is that in much of traditional philanthropic activity, for example, in private foundations, there is a requirement to spend a certain proportion of money from the funds that have been donated to the foundation, whereas this is not necessarily the case for some other forms of organization that are now being used to pursue philanthropy, such as limited liability companies (LLCs) and donor-advised funds (DAFs). Could you explain some of these differences and the impact they are having?

Brakman Reiser: In the US, actually, a foundation is not a legal form, it is a tax classification. It was set up to be attractive for elite donors to use this particular tax-classified entity for their philanthropic activity if they wanted to do what you have described: to put a pot of money aside and make grants from that. That would likely qualify as a foundation and thereby provide tax exemption for the income on that pot of money. It would also potentially provide tax benefits to the donors when they make their donations. As I'm sure we'll discuss more, at the time this was put in place, those benefits for donors were worth a lot more than they are in the modern world of U.S. taxation. If you want to set up a foundation, you absolutely still can, and many elite philanthropists still do operate foundations in the U.S. But they increasingly have a menu of choices of how to structure their philanthropic activity, and they don't even have to make just one choice. For example, they could have a foundation operating under the umbrella of a limited liability company, and also use a donor-advised fund.

A limited liability company is not a non-profit organization. It is a company, it's a for-profit business form, so it wouldn't qualify to be a tax-exempt foundation. But it also comes with the advantage of being entirely flexible for the founder of the limited liability company. Limited liability companies are regulated by contract, and you can set up your contract to govern them in myriad ways. It's extremely flexible, which is why it's a really popular business form. It won't qualify as a foundation, which might be a problem if you're worried about those tax advantages, but as the tax advantages become less valuable that trade-off looks a lot better in terms of the flexibility that donors have when they use an LLC.

They also have flexibility in terms of other features that would be circumscribed by using a foundation form. We already mentioned one of them, which is that foundations are required to make certain disclosures publicly. With an LLC, you don’t have to do that. You can be as transparent as you want to be, and some LLCs have been fairly transparent about many things, but we don't even know if any given LLC exists.

The other respect in which they can be quite flexible is in how they pursue their philanthropic agendas. A lot of the philanthropy regulation and law that I've been referencing is made up of limitations on how foundations, these tax-classified entities, can function. And they are limited in doing business with affiliated entities of their donors, so they can't co-create very easily with their founders, they can't engage in political activity, and they also have some limitations on the kinds of investments that they can make. They can go all out making charitable grants, but if you want to use some other tools in your toolbox to achieve social change, if you want to co-create with your company, if you want to use political contributions, if you want to invest in companies that have some kind of social return embedded in them, it can be hard to do that, or impossible to do that in a foundation form. So, the LLC gives all that flexibility. And if the tax losses aren't so great, it starts to look a lot better, which is why we see this trend developing of using those forms.

RF: OK, so much for foundations and LLCs. Something you also spend quite a lot of time on in your book is the DAF – the Donor-Advised Fund – yet another tool on the rise. Could you tell us a bit more about this?

Brakman Reiser: A donor-advised fund is a bit different. A donor-advised fund is basically a kind of account within a sponsoring organization, and that sponsor is technically a tax-exempt non-profit entity. You make your donation to the fund that is then controlled by the sponsor, and once you do, you can't get it back. So, it's asset-locked in that way, which an LLC isn't. If you change your mind about your philanthropic LLC, you can just take your money back out and do something else with it.

But with a donor-advised fund, it's locked in there, and it can only be used for the purposes of grant-making for charitable entities. However, it also is much less transparent than a foundation and the most popular sponsoring organizations here in the U.S. for these donor-advised funds are affiliates of investment firms. So, there is this kind of move by a for-profit industry to stake out a space where they are managing these assets, which ultimately will be directed by the donors who set up the accounts. They can give advice on where it should go, and even their heirs can give advice often on where it can go, but we don't have the same transparency that we would have if the donors had made their grant to a foundation.

Of course, for small donors, it wouldn't make sense to set up a foundation, so one can see the potential use-case for DAFs for such small donors. But what we are also seeing are billion dollar donor-advised funds being used, where a much more transparent, much more heavily regulated form, like a foundation, could have been used. I think these attractive qualities around the lack of transparency, and, flexibility, for example in terms of when you have to make payouts, as you mentioned, are attracting large donors to these options as well.

RF: Something you mentioned a few times there are tax advantages and the ways those are changing and donors are adapting to those changes, Prof. Dean, this sounds like one for you. We hear a lot about American philanthropy being driven by tax advantages or tax-optimization. What exactly are the kinds of activities that qualify for such a tax exemption?

Dean: In the U.S we do much more than other jurisdictions to utilize tax expenditures, which are sort of tax benefits we allocate through the code. It’s sort of like chicken soup: for everything that we think needs to be taken care of, we'll create a tax credit. For example, we have a tax credit for electric cars. We could just subsidize the making of electric cars, but we don't do that. We do a lot of spending through the tax code, so we have a much more complicated code that encourages people to do things: buy electric cars, build a certain kind of home, tuition benefits for college. Again, this is separate from actually just making college cheaper, which I think would be maybe a more sane way to do it, but this is the way we do it.

And for charitable activities, we do the same thing: we allow a tax deduction for charitable activities. On the one hand, it, in theory, encourages people to make charitable contributions. Unfortunately, for many taxpayers, this is no longer true. For a variety of reasons, only a very small fraction of taxpayers, something around 10%, are in a position to actually take advantage of that deduction.

However, there's another way to think about what the tax rules do, and it's not that different. When you think about Andrew Carnegie's Gospel of Wealth, which, I think is helpful as a way to think about the American philosophy here, even though it was written close to 200 years ago, his vision was: ‘I'm a really smart guy, and I got rich by being smarter than everybody else. So, the last thing I want to do is give all this money to idiots in government who I'm much smarter than. It will be much better if I were to spend all these profits myself, because I'm going to do a much better job than anybody. Certainly better than the masses that I took it from, and even better than government.’ So what he advocated for, and what we kind of have is an estate tax, not to ever actually be collected, but to act as an incentive, for people like Carnegie to do what he did during his lifetime and give away the money he’d collected, allowing them to show the same smarts when they reverse the vacuum cleaner they used to suck up all that wealth. To make sure that it's used for the right things, universities, libraries, the kinds of things that Carnegie thought were important.

That's also the theory of these deductions. They encourage people to do the right thing: to spend the money during their lifetime and not hand it over in taxes. That would be a mistake.

And this is consistent with our story of for-profit philanthropy: people using their business smarts to do good in big ways that lots of little do-gooders couldn't match. So a few Andrew Carnegies can really have a great impact.

RF: ‘To do good’ is definitely a phrase you hear a lot now, and also ‘to do well by doing good’. Has what qualifies as ‘doing good’ become an overly broad term at this point? I think if someone fed the poor or clothed the needy or gave medical attention to those in need, few people would dispute that good has more or less been done.

But it does feel like organizations today are basically engaged in advocacy under the official title of philanthropy, things that may not technically qualify as partisan-political, but that are still quite political in the broad sense of achieving political goals rather than engaging in what most people would consider to be charity per se. Has the definition of charity become too loose?

Brakman Reiser: An advocacy organization would not qualify for those same tax benefits as the kind of charitable entity that you're describing. So, there is a variation. That being said, it's not that there are no abuses or no edge cases, there certainly are, but part of what is motivating the use of alternative structures, particularly the LLC and strategic giving by corporations, is that using a foundation really restricts any kind of political activity to essentially zero. Even voter registration is quite limited for a foundation. They cannot make grants for lobbying activity, and they cannot make grants for election or campaign-related activity.

RF: Still, while they may not participate politically in the sense that they didn't campaign on behalf of a party, there are plenty of ways to affect the politics of a country without doing that.

Brakman Reiser: If an entity engages in advocacy, they can only receive grants from a foundation if the foundation can provide additional documentation that the money will only be used for charitable purposes by that entity. So that entity might do advocacy, but it will only use the foundation's money for charitable activity.

RF: If I think of something like the Omidyar Network, they have Democracy Fund, which is a 501(c)(3), and Democracy Fund Voice which is a 501(c)(4), and then money gets channeled through these two different forms, and more besides.

Brakman Reiser: Well, remember, the Omidyar network is not operating a foundation.

RF: Still, it feels like, maybe this is just my impression, but sometimes I look at something like the Omidyar Network which has something approaching a dozen sub-organizations that the money flows through, and they seem to just kind of use whatever form they want to use. So, do these various legal forms at this point, serve any purpose or have these restrictions de facto been eroded?

Brakman Reiser: Only the 501(c)(3) tax-exempt entities qualify for the most generous tax advantages. That’s the bargain that our tax code makes, if you stay in this narrow lane, and you support only charitable activities. You can do a lot of other things, but you won't get that tax treatment, and that has historically really channeled a lot of giving toward these foundations who qualify for the most generous advantages.

But as Steve knows better than me, changes at the level of the tax code and how it impacts particularly very high net worth individuals and big companies, those advantages are not enough to sway them to use primarily that tool, and so you see this proliferation of alternatives.

Dean: To be very precise, it's not necessarily changes in the tax code so much as changes in the world. A hundred years ago, the Rockefellers and the Carnegies earned really big salaries, which is how we ended up with an income tax, because we thought we were going to solve all our problems by taxing income, and we still do that and some people still do earn pretty big salaries, but most of the wealth of Omidyar and all the other philanthropists these days has come through appreciation and stock ownership of their companies. So, they aren't earning taxable income, they're just watching their shares grow in value. And they don't have current tax liability for that economic income. So they're not worried about getting a tax deduction. There’s been a failure to change the tax code. Therefore, there’s no pressure to channel your activities into a certain kind of organization.

RF: To go into that point of regulation and societal evolution, you refer often throughout your book to a kind of Grand Bargain that was struck, in the United States in the late 1960s, as a way to allow but also regulate elite giving. Could you point to any specific rule that you feel has either changed or failed to keep pace with change to the point where renewal is necessary? What do you think are the one or two most important points of regulation of philanthropy that are being undermined today?

Dean: 60 or 70 years have passed since the late 1960s. You could strike any bargain and let that time pass and you’d have a problem. Laws need to be updated. If I could change one thing, it would be to actually tax the extreme wealth and income. I don't think we'll actually ever tax them. I don't think we have the courage to do that, but if, at the very least, we had a system that threatened them with tax, as Carnegie wanted to do, that would be the thing. There needs to be a reasonably realistic threat. Even though, as I say, we would never actually collect a billion dollars from Elon Musk in taxes. That's not something that's going to happen. But we can at least threaten to do that so that he chooses either to do that thing or spend the money in ways that are consistent with the rules we've set up that do channel it into some societally productive activities.

Brakman Reiser: I think I would look at the other side of the ledger. Steve is saying, we need to make sure that part of this bargain is that you're actually going to get something out of it, so it would encourage you to do the thing that we want you to do. I think this is really important because we identify in the book that there are certain kinds of policy goals of the law that we have, around transparency, around targeting activity only to these kinds of charitable grant-making vehicles. Also the rules around timing – how much needs to be paid out by a certain time. Those need updating, too. The 5% payout requirement for foundations is very modest. That could potentially be much higher.

We need to think about transparency as a value. We see today the pressure in the U.S. on non-profit organizations to align their activities to the values of a particular political administration. Being opaque can actually potentially shelter dissent, and so maybe we want to rethink our values there. So I think we need to update, but we need to update on both sides. We need an updated version for our current times.

RF: Something that really, really interested me about your book is that you did refer at several points to a tension between democracy and philanthropy. In fact, at one point, I think you said that philanthropy was inherently anti-democratic in nature. Could you unpack that?

Dean: One of my favourite philanthropists is Julius Rosenwald. Julius Rosenwald during the Jim Crow era in the United States, a time of segregation and legal widespread discrimination, used his fortune to build schools in the South for Blacks. This is my favorite kind of anti-democratic behavior, because that isn't what the majority in the South wanted to happen. But he decided this was important and he made that happen.

I don’t think this was quite what Dana was suggesting, but it's certainly true that we have to be careful and thoughtful about what transgressive looks like. When we say anti-democratic, anti-democratic can be things that we really value, that I personally value very highly and think we should, but just aren't being rewarded by any particular administration.

Brakman Reiser: At its base, a democratic redistribution of wealth is one that is run through a democratic process. So you would have a democratically elected Congress setting in place a tax code, and then the money would come in, and you would distribute it along the lines preferred by the democratically elected officials. And that's not what happens in philanthropy. The money doesn't get paid in tax, and an individual gets to decide how to deploy it, for some sort of vision of social good. So at that level, it's anti-democratic. It doesn't necessarily mean it's always good or always bad, and your values are going to vary, and that's exactly what philanthropy enables. It enables a kind of pluralism, that I think is really valuable, sometimes because the philanthropist will do things that I like, like Julius Rosenwald, but even when philanthropists are doing things that I don't like, I think the pluralism of the sector and its ability to spur innovation and kind of shelter novel and unpopular ideas is really important in a democracy.

RF: Ok - just to try to get a handle on the exact parameters of your criticism, which is very weighed, you see a lot of disadvantages with the way philanthropy is run today, but you still see that there are advantages to philanthropy. There are things philanthropists have funded that otherwise may not have gotten done and some of those things live on in ways that are very positive.

On the other hand, I suppose I could say, from a democratic point of view, sometimes people have put their money into these various funds, DAFs, or foundations, or whatever in order to avoid paying tax, either in an immediate sense through deductions or to paper over the fact that they are paying very little compared to the average taxpayer, and this is fine because they are doing all this wonderful experimentation. That’s not something that I get to do as the average taxpayer. I just have to pay my tax. It does feel very unfair that the wealthiest members of society get a free pass to experiment with their wealth, while the rest of us are stuck paying the tax. Certainly everyone wishes they could experiment on things they prefer, rather than have to pay for a basket of things they like and don’t like.

Dean: The kinds of books that I write make very clear that I'm in favor of very rich people paying a lot of tax. I think that would be a very good thing. But the world I live in, and certainly the tax laws that I am familiar with make it very clear that is not even close to happening. I would love one of the wealth taxes that have been discussed in the U.S. in recent years to be enacted. That would be delightful. But as I say, I'm confident that even if they were, there would be a charitable deduction associated with them. I would find that very surprising if one of these taxes were created, and it actually didn't include an unlimited charitable deduction or exemption or whatever they frame it as. And that's just the reality of the world we live in. And I don't know, other jurisdictions may be different and may strike a different balance in terms of plutocracy and democracy. But that's the one we live in, and I don't think eliminating the tax benefits for philanthropy will change that. I think that's just sort of a broad political economy story that we're stuck with for the time being. We've seen radical change in recent years, and maybe the radical change can go in a different direction in the future. But for now, I think that's where we are.

Brakman Reiser: I completely agree. The only thing I would add is that a very rich person can choose to not pay tax and do something else with their money, too. No one is forcing them to not pay tax by engaging in charitable activity. They cannot pay tax, the estate tax that Steve was referring to at the beginning of our conversation, by buying more yachts, or generally by being a spendthrift. So, I don’t think the benefits for charitable activity are any worse than that, but I do think we, as a society, should think about what it is we're trying to channel people into and rethink that question.

RF: OK, well, thank you once again for taking the time to talk with me today.

Brakman Reiser: Thank you for being in conversation with us.