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Sunday, May 16, 1993 - Page updated at 12:00 AM

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Warehouses Of Wealth -- Nonprofit Groups Thrive In System Ripe For Abuse

Philadelphia Inquirer

First of four parts

The National Football League, that bastion of free enterprise and million-dollar quarterbacks, doesn't look like a nonprofit organization. But it doesn't act like one, either.

The NFL spends less than 1 percent of its $35 million budget on charitable activities, pays its commissioner $1.5 million a year, and spends $1.5 million to lease seven floors of a Park Avenue office tower.

Or take the Motion Picture Academy of Arts and Sciences, which spent $6 million to put on the dazzling Oscars show.

You thought nonprofit organizations had to be charities, run by meagerly paid managers and volunteers?

Not anymore.

Thanks to the remarkable largess of Washington lawmakers, an ever-expanding definition of charity, and a near-total collapse of government supervision, America's nonprofit economy has become a huge, virtually unregulated industry.

Many nonprofits undoubtedly fulfill their mission of providing charity. But others seem focused on accumulating wealth, or making a profit.

Within this nonprofit world, almost anything and anybody qualifies for tax-exempt status.

Auto racing promoters. Collection agencies. Country clubs. Criminals. A half-billion-dollar defense research corporation. Investment houses. Mail-order colleges. A polo museum. Retail stores. Professional surfers. An association of Druids. Foreign real estate investors. Space explorers. Even a chili appreciation society.

Each year for the last dozen years, an average of 29,000 new groups have been declared nonprofit and gone off the tax rolls. Today, an estimated 1.2 million organizations are exempt from taxes - not counting churches.

Think of it as Congress' contribution to charity.

And you make up for the taxes they don't pay.

A major but little-noticed change has taken place in the American economy in the last 20 years: the dramatic growth of nonprofit businesses.

These businesses had an estimated $500 billion in revenues in 1990 - nearly six times the income of farms, five times that of utilities and twice as much as the construction industry.

They represented roughly 6 percent of the nation's total economic output and employed about 7 million people.

Since 1970, this tax-exempt sector has grown four times as fast as the rest of the economy.

Nationally, nonprofits control property, cash and investments worth more than $850 billion - and that is a conservative estimate. Because neither churches nor smaller nonprofit groups have to report income or assets, the true figure probably exceeds $1 trillion.

Calculations, based on federal estimates, congressional hearings and interviews with economists, suggest lost tax revenue of

$37 billion a year, and probably much higher.

Nonprofit groups do a lot of good in a lot of areas for a lot of people. That's why they were granted exemption from taxation. But as Congress has become more and more liberal with the nonprofit designation, and as the Internal Revenue Service has become swamped, abuses have grown.

An 18-month study, which included examination of tax returns of 6,000 nonprofits, found that:

-- Many nonprofits operate just like for-profit businesses, creating huge warehouses of wealth. They make huge profits, pay handsome salaries, build office towers, invest billions of dollars in stocks and bonds, employ lobbyists and use political action committees to influence legislation.

-- Nonprofit hospitals, originally exempted from taxes because of their charity care, now devote an average of 6 percent of expenditures to caring for the poor. Meanwhile, more than $1 billion in hospital profits have been shifted to commercial spinoffs - hotels, restaurants, health spas, laundries, marinas, parking garages.

-- Private, nonprofit colleges and universities have more than doubled their tuition in the last decade, even though their income from investments was doubling and tripling in the 1980s. Some schools now spend more on research than on teaching.

-- Most private foundations give away only the minimum required by law, 5 percent of their assets each year, while earning much more on investments. With $163 billion in assets, they are operated like private banks, with elite, self-perpetuating boards of directors.

-- A multibillion-dollar pool of cheap money, available through low-interest loans to tax-exempt organizations and subsidized by taxpayers, has financed a massive expansion of hospitals and universities. Some have overbuilt: On any given night, one third of the hospital beds in America are empty.

-- Dozens of directors and executives of nonprofits own or are officers of outside companies that do business with the nonprofit. The services they provide range from legal and financial advice to selling the nonprofit food or other goods. The IRS requires disclosure of such relationships, but only minimal details about finances.

-- Because churches enjoy special tax-exempt status, the IRS does not know how many exist. The IRS has no idea how much property or money is controlled by churches. Nor does it know how many churches operate travel tours, nursing homes, retirement villages or other commercial businesses.

Virtually any individual or group may declare itself a church, collect money and pay no taxes.

The IRS cannot examine a church's financial records without undertaking complicated negotiations with the church.

Even if a church agrees, the examination is restricted to a two-year period.

Don't be misled by the word "nonprofit." It does not mean these groups cannot earn a profit on their services. They make plenty of profit - although they don't call it that.

Under the federal tax code, nonprofit businesses may accumulate net income, so long as they don't distribute it as dividends or stock. Where does the money go then? In many cases, to expand their empires.

That means to construct new buildings, expand services, acquire competitors, increase executive salaries and hire high-priced consultants, among other things.

"I call it the culture of the nonprofit," said Princeton University economist Uwe Reinhart. "You can't keep the money for yourself, right, so you do the next best thing. You put up another building or give yourself a raise. As a nonprofit, who's going to question this?"

This is big business, by anybody's definition. Many nonprofit businesses are highly profitable.

A computer analysis of 630 large nonprofits found that they had an average profit margin of 9 percent in 1990 - more than double the average of Fortune 500 companies.

These big profit margins are, in part, the result of not having to pay taxes. If these were for-profit companies, they would have to pay up to $340,000 in federal income taxes for every $1 million in operating income. They also would be subject to a maximum 28 percent capital gains tax on any investments they sold. And they would have to pay local property, sales and other taxes.

NONPROFITS' DEFENSE

Many nonprofits defend their tax-exempt privilege by citing their economic contributions to their communities.

Such economic power is important. But it has nothing to do with why hospitals, universities or other nonprofits were exempted from taxes. Those reasons have to do with their charitable and social missions, not the jobs they create.

Otherwise, large private businesses would be tax-exempt, too.

Another argument nonprofits often make is that they've been forced to start for-profit businesses to provide revenue to run their exempt operations.

Their tax-paying competitors, though, say nonprofits are not merely protecting existing operations but expanding into new businesses.

Moreover, tax-paying competitors complain, nonprofit businesses have unfair advantages. If a for-profit company in New Jersey spends $500,000 on new equipment or furnishings, it pays a 6 percent sales tax, or $30,000. A nonprofit buying the same equipment pays no tax.

Such advantages have helped nonprofits gain a foothold in some businesses that have been dominated by private tax-paying firms - fitness centers, for instance.

For years, fitness centers and spas were the domain of private companies. But in the 1980s, nonprofit hospitals invested more than $500 million in such centers.

`COMMERCIAL NONPROFITS'

Commercial activities of nonprofits extend to their tax-exempt services, too. Yale economist and tax attorney Henry Hansmann, an authority on nonprofits, has coined a term for such groups. He calls them "commercial nonprofits."

"These are nonprofits that derive substantially all of their income simply from the prices they charge for the goods and services they produce, and receive no meaningful donative support," Hansmann said at a 1987 congressional hearing.

Hansmann has recommended that Congress consider revoking the exemptions of these fee-based nonprofits.

"The critical question is whether the nonprofits in question provide the kind and quality of service that is unavailable from for-profit firms in the same industry," Hansmann testified in 1988.

"If they do not, then the case for tax exemption is quite nebulous. At most, it will simply produce a larger volume of services . . . and if this is what is desired, then we must ask why we do not extend the tax exemption to the for-profit firms as well."

REVENUE MACHINES

In 1991, about three-quarters of the revenues reported to IRS by large nonprofits came from selling services - such things as books, educational and health services.

All but overlooked by mainstream economists, this reliance on fees and sales of services represents a fundamental shift in the nature of charities.

And it raises important questions about how and whether these organizations are different from tax-paying businesses.

Over the next three days, The Times will offer a detailed look at three key types of large nonprofits: Tomorrow: Hospitals Tuesday: Colleges Wednesday: Foundations

Copyright (c) 1993 Seattle Times Company, All Rights Reserved.

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