Tax Expenditures in the Nonprofit Sector
The federal government indirectly subsidizes the nonprofit sector through federal tax deductions, exemptions, credits and exclusions. Subsidyscope estimates that for fiscal year 2008, tax expenditures that target nonprofit organizations totaled over $50 billion (see Table 1).1 The largest single nonprofit-related tax subsidy is the tax deduction for charitable giving which cost the government nearly $47 billion in lost revenue in fiscal year 2008.2 In addition to the tax expenditures that specifically target the nonprofit sector, there are tax subsidies that are aimed at certain types of services for which nonprofit organizations are common, but not exclusive, suppliers.
A rationale for subsidizing nonprofits through the tax code is that goods and services often supplied by nonprofits, such as education, are underprovided by profit-driven markets. To compensate for the relative scarcity of these goods and services, governments can encourage individuals and corporations to support nonprofit organizations through the tax code, such as allowing a tax deduction for charitable giving. More on the specific rationale for the charitable deduction is here.
Tax Subsidies That Target Nonprofits
Table 1 lists five tax expenditures that must involve a nonprofit for the tax benefit to be claimed by the taxpayer.3 Each is discussed in detail below.
Table 1: Tax Expenditures for Individuals and Corporations That Target Nonprofits ($ millions)
|Deduction for Charitable Contributions:|
|for Institutions Other than Education and Health||$38,200||$43,370||$46,980||$50,550||$54,600||$59,070||$62,790|
|for Health Organizations||$4,310||$4,890||$5,300||$5,700||$6,160||$6,660||$7,080|
|for Educational Institutions||$4,330||$4,880||$5,270||$5,670||$6,110||$6,600||$7,010|
|Exemption of Credit Union Income||$1,140||$1,190||$1,230||$1,280||$1,330||$1,380||$1,430|
|Exclusion of Interest on Bonds for Private Nonprofit Educational Facilities||$860||$1,870||$1,960||$2,110||$2,260||$2,320||$2,390|
|Special BlueCross BlueShield Deduction||$620||$600||$650||$660||$670||$680||$690|
|Exclusion of Housing Allowances for Ministers||$550||$580||$620||$660||$700||$740||$790|
Source: Subsidyscope compilation of data from OMB. “Analytical Perspectives, Budget of the U.S. Government, Fiscal Year 2010.” pp. 300 -302. OMB presents Treasury Department estimates based on current tax law as of December 31, 2008; future years are projections.
The Deduction for Charitable Contributions
The largest tax subsidy that targets nonprofits is the deduction for charitable contributions. The federal government subsidizes donations to qualified charities by allowing taxpayers who itemize to deduct those donations from their pre-tax income.4,5 In fiscal year 2008, this tax subsidy cost the Treasury nearly $47 billion of revenue.6
This provision benefits nonprofits and taxpayers by lowering the cost of charitable giving. The amount of the tax subsidy rises with the taxpayer’s marginal tax rate. For example, a taxpayer who is subject to a marginal rate of 25 percent and makes a donation of $1000 to a charity will save $250 on their taxes and, thus, only end up spending $750 in order to donate $1000, after the tax deduction. (Without the deduction, the taxpayer would have paid $250 more in taxes.) By comparison, using the same computation, a taxpayer subject to a marginal tax rate of 35 percent would spend $650 donating $1000 to a charity.
Taxpayers who claim this deduction share its benefit with the nonprofits to which they give. In order to determine what share of the benefit goes to nonprofits, one must know how much these taxpayers would have donated in the absence of the tax subsidy. Unfortunately, there is no clear answer to this question. Regardless, it is by far the largest federal tax expenditure targeted to nonprofits.
Exemption of Credit Union Income
Federal and state chartered credit unions are typically organized around certain membership groups (e.g., employees of an organization) and do not operate to make a profit. Like other nonprofit organizations, credit unions are exempt from the federal income tax. However, the exemption of credit union income is considered a tax expenditure by the Treasury Department. This exemption cost the government $1.1 billion in fiscal year 20087 and results in credit unions paying their members higher dividends on their deposits and charging them lower interest rates on loans.8 More information on this tax subsidy can be found here.
State and local governments issue tax-exempt bonds.9 Some of these bonds help finance activities or facilities often used by nonprofit organizations such as the construction of hospitals and nursing homes. This provides a subsidy because interest payments on the bonds are exempt from income tax. The bonds lower the nonprofit’s costs because investors accept a lower rate of interest due to the tax benefit. Thus, many bond buyers and nonprofits share the benefit from this tax subsidy.10 Government-issued tax-exempt bonds are generally not targeted at nonprofit organizations so Subsidyscope classifies them as incidentally benefiting the nonprofit sector and lists them in Table 2 below.11 One category of government-issued bonds specifically finances private nonprofit educational facilities such as classrooms and dormitories.12 These bonds cost the government an estimated $860 million in lost revenue in 200813 and are listed as a subsidy targeted at nonprofit organizations in Table 1.
The Special Deduction for BlueCross BlueShield
BlueCross BlueShield initially received a special federal tax deduction because it provided community rated14 health insurance, including the provision of high-risk and small-group coverage.15 BlueCross BlueShield was a tax-exempt organization until that status was overturned by the Tax Reform Act of 1986; however, the special deduction was left in place. This deduction is estimated to have cost the Treasury approximately $620 million in FY 2008.16
Exclusion of Housing Allowance for Ministers
Expenditures on housing that churches provide to ministers are not taxable. An effect of this provision is that churches may be able to pay ministers a lower salary since their cost of housing is effectively reduced. In this sense, the tax exclusion benefits both the ministers—who pay less income tax—and the nonprofit churches they serve. The government subsidized churches and ministers through this exclusion in 2008 by foregoing $550 million of revenue.17
Tax Subsidies Incidentally Benefiting Nonprofits
Table 2: Selected Tax Expenditures That Incidentally Benefit Nonprofits (In Addition to Other Entities)
|Exclusion of Employer Contributions for Medical Insurance Premiums and Medical Care|
|Deductibility of Medical Expenses|
|Self-Employed Medical Insurance Premiums|
|HOPE Tax Credit|
|Credit for Child and Dependent Care Expenses|
|Lifetime Learning Tax Credit|
|Exclusion of Scholarship and Fellowship Income|
|Medical Savings Accounts/Health Savings Accounts|
|Deduction for Higher Education Expenses|
|Exclusion of Interest on Hospital Construction Bonds|
|Deductibility of Student Loan Interest|
|State Prepaid Tuition Plans|
|Exclusion of Employer-provided Educational Assistance|
|Work Opportunity Tax Credit|
|Adoption Credit and Exclusion|
|Distributions for Retirement Plans for Premiums for Health and Long-Term Care Insurance|
|Exclusion of Interest on Student Loan Bonds|
|Special Deduction for Teacher Expenses|
|Credit for Holders of Zone Academy Bonds|
|Credit for Disabled Access Expenditures|
|Education Individual Retirement Accounts|
|Employee Retention Credit for employers in Certain Federal Disaster Areas|
|Exclusion of interest on Savings Bonds Redeemed to Finance Educational Expenses|
|Discharge of Student Loan Indebtedness|
|Tax Credit for Health Insurance Purchased by Certain Displaced and Retired Individuals|
Source: Subsidyscope compilation of data from OMB. “Analytical Perspectives, Budget of the U.S. Government, Fiscal Year 2010.” pp. 300 -302; 304.
A number of tax expenditures are targeted at certain types of services that are often, but not exclusively, provided by nonprofit organizations. In its report on federal funding of the nonprofit sector, the Government Accountability Office (GAO) discusses these other tax benefits.18 For example, GAO presents the exclusion of employer contributions for medical insurance premiums and medical care from a company’s taxable income, which subsidizes both nonprofit and for-profit health care providers as well as employees. Unfortunately, there are no reliable estimates on how much this, or other such tax subsidies, directly subsidize nonprofits.
GAO presents a short list of tax expenditures that benefit nonprofits as well as other entities; however, GAO emphasizes that it did not attempt to identify all tax expenditures that benefit nonprofits. Subsidyscope begins with GAO’s list, and further identifies other tax expenditures for which some of the benefit flows to nonprofits. While Subsidyscope does not include these subsidies in the overall estimate of subsidies the nonprofit sector receives, users of this site should be aware of these large non-targeted tax provisions that can incidentally, but significantly, benefit the nonprofit sector. Table 2 below provides a list of such tax expenditures. The scope of this table is limited to tax expenditures for activities presented by the OMB as falling in the budget functions “Education, Training, Employment, and Social Services” and “Health.” Nonprofits performing activities in these two areas comprise about 64 percent19 of all nonprofits, 88 percent of the sector’s revenues and 82 percent of its assets.20
Tax Exempt Status of Sector
Subsidyscope defines the nonprofit sector as any organization exempt from federal taxation under subsection 501(a) of the Internal Revenue Service code.21 This includes so-called 501(c)(3) and 501(c)(4) organizations such as religious institutions, charities, civic organizations and private foundations. Click here to read Subsidyscope’s Summary of the Nonprofit Sector.
While the nonprofit sector is exempt from federal income taxes, Subsidyscope does not consider tax exemption for nonprofits a federal subsidy. This is for two reasons. First, the exemption was not conceived as a tax subsidy. The tax exemption was originally an attempt to define the corporate income tax base and determine which activities of traditional nonprofit organizations should remain outside the sphere of government. As such, the tax exemption does not constitute a subsidy because the income from the non-business activities of nonprofit organizations was never intended to be taxed in the first place.22
Second, the federal government does not recognize the exemption as a tax expenditure. Neither the Office of Management and Budget nor Congress’ Joint Committee on Taxation list the sector’s tax-exempt status as a tax expenditure, thus neither of these entities estimate the amount of revenue lost from the tax exemption.
Nonetheless, attempts have been made at estimating the sector’s untaxed revenue. For example, an Urban Institute study estimated that the potentially taxable income of public charities was $25.4 billion in 2002, the equivalent to an income tax savings to nonprofits (and a loss to the government) of $10.1 billion.23
- This number derived by adding up the tax expenditures listed in the 2008 column of Table 1. Office of Management and Budget (OMB). “Analytical Perspectives, Budget of the U.S. Government, Fiscal Year 2010.” pp. 300-30. Summing tax expenditures does not account for the potential interactions among different types of taxes; however, in this case, the potential interactions are modest and thus it provides a reasonably good estimate of the total cost to the Treasury of the tax expenditures that are specifically targeted to the nonprofit sector.
- This number derived is from adding up the deductibility of charitable contributions for the categories of “education,” “health,” and “other than education and health” for 2008. OMB. “Analytical Perspectives, Budget of the U.S. Government, Fiscal Year 2010.” p. 301.
- It is important to note that the indirect nature of the tax subsidies and other measurement issues precludes a definitive estimate of the subsidy that nonprofits actually receive.
- Internal Revenue Service (IRS), “Charitable Contribution Deductions (Publication 78 Help, Part II).” High-income taxpayers face certain limits on the amount of itemized deductions that they can subtract from their income.
- Charitable bequests can be also deducted from federal estate taxes. This deduction operates similarly to the charitable giving deduction for the income tax, and effectively lowers the cost of donating to a charity. For practical reasons, the scope of Subsidyscope’s analysis does not currently include tax subsidies, such as this, that occur outside the income tax system. In general such subsidies are small, but this is an exception. Estimates show that the average amount of charitable bequests rose steadily over the past twenty years and reached $20 billion in 2004 (See Joulfaian, David. “On Estate Tax Repeal and Charitable Bequests.” (June 8, 2009). Tax Notes. Vol. 123, No. 10, 2009. p. 1221; and Brody, Evelyn and Joseph J. Cordes. “Tax Treatment of Nonprofit Organizations: A Two-Edged Sword?” in Nonprofits and Government: Collaboration & Conflict, 2nd ed., The Urban Institute Press. Washington DC, 2006. p. 161.)
- See footnote 2.
- Ibid., 304.
- Congressional Research Service (CRS). “Tax Expenditures: Compendium of Background Materials on Individual Provisions.” December 2008. GPO: Washington DC. p. 295.
- When state and local bonds pay for government facilities that serve the public interest, they are called “governmental bonds.” Other bonds issued by state and local governments are called “private activity bonds” and are not tax exempt. However, private activity bonds issued for construction of certain facilities, such as nonprofit university, hospitals and nursing homes, are tax exempt due to the fact that there are both private and public beneficiaries of these institutions. For more on private activity bonds, including volume limits that may apply, see this IRS Publication entitled “Tax-Exempt Private Activity Bonds.”
- CRS. “Tax Expenditures: Compendium of Background Materials on Individual Provisions.” December 2008. GPO: Washington DC. p. 612.
- The CRS estimates the tax revenue lost due to tax exempt bonds specifically for nonprofits hospitals, but the OMB fails to separate out the nonprofit and for-profit recipients of the subsidy. Thus we do not report the estimates here.
- Tax-exempt bonds are also used to finance the construction of hospitals, many of which are nonprofit organizations. However, Subsidyscope presents tax expenditure estimates that are produced by the Treasury Department for the OMB and these estimates do not break out the portion of that tax subsidy that benefits nonprofit versus for-profit hospitals.
- OMB. “Analytical Perspectives, Budget of the U.S. Government, Fiscal Year 2010.” p. 302.
- Under “community rating,” an insurer charges all people covered by the same type of health insurance policy the same premium without regard to age, gender, health status, occupation, or other factors. The insurer determines the premium based on the health and demographic profile of the geographic region or the total population covered under a particular policy that it insures. See more here.
- CRS. “Tax Expenditures: Compendium of Background Materials on Individual Provisions.” December 2008. GPO: Washington DC. p. 314.
- OMB, “Analytical Perspectives, Budget of the U.S. Government, Fiscal Year 2010,” p. 305.
- GAO, “Significant Federal Funds Reach the Sector through Various Mechanisms, but More Complete and Reliable Funding Data Are Needed.” February 2009. GPO: Washington DC. P. 26.
- The Urban Institute. Nonprofit Almanac 2008. Washington DC, 2008. p. 144. Number derived by adding the rows labeled “Education,” “Human Services” and Health.”
- The Urban Institute. The Nonprofit Sector In Brief. Washington DC, 2008. p. 2.
- This is the same definition used by the Government Accountability Office. See GAO. “Nonprofit Sector: Significant Federal Funds Reach the Sector through Various Mechanisms, but More Complete and Reliable Funding Data are Needed.” February 2009. pp. 24-25.
- Brody, Evelyn and Joseph J. Cordes. “Tax Treatment of Nonprofit Organizations: A Two-Edged Sword?” in Nonprofits and Government: Collaboration & Conflict, 2nd ed., The Urban Institute Press. Washington DC, 2006, p. 153.
- Ibid. p. 150.