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Foundations and the Future: How Funder Incentives Affect Nonprofits, Grants, and Grant Writing

“New Voices Of Philanthropy”* is running an occasional series in which they invite bloggers involved in the nonprofit world to contribute; I’m tardy to this month’s question:

Will the Foundation of the Future only fund programs that benefit puppies and children? Will it be run by people that have attained the elusive PhD in Philanthropy? Will the Foundation of the Future actually be the donor advised fund of the future, since foundations are outlawed by Congress in 2016?

The short version: I think foundations in the future will be run much as they are in the present.

The longer version: most foundations seem to be run chiefly for the social prestige and well-being of the people running them. The primary evidence I can discern seems to fall into two categories, the first one stronger and more important than the other: foundations tend only to give away the minimum 5% of their assets every year, as required by law, and they tend to make the process through which nonprofits acquire funding unnecessarily arduous.

The New York Times has reported on a study done by a Barnard economics professor that found “[c]haritable foundations could give away 60 percent more money than they do now without eroding the total value of their assets” (emphasis added). His paper is available here (warning: .pdf link). The upshot is that foundations appear to hoarding money, and, as the study itself says:

[…] Congress intended to keep tax-favored foundations from becoming mere warehouses of wealth. To the extent that the foundation section operates as if though it were a non-endowment system, paying out new giving while allowing existing assets to compound in perpetuity, the foundation sector is in danger of appearing to be exactly what Congress wanted to prevent […] To the extent that individual foundation reduce payout to the legal minimum simply in order to increase their assets under management, they defeat the real social purpose of their privileged tax status[…]

In a similar vein, Akash Deep and Peter Frumkin wrote a paper, “The Foundation Payout Puzzle,” and found that “the average payout rate of this sample of foundations over time, as the policy regime has shifted slightly from a flat 6 percent, to the greater of total investment income or 5 percent, to a flat 5 percent” from 1972 to 1996. This, they later conclude, is bad because a dollar spent today would probably be more effective than a dollar spent tomorrow, assuming that the needs being addressed are important to the recipients.

Since they’re scholars, they give a long and detailed discussion about why foundations don’t increase their payouts. Since I’m a blogger, I’ll be short, mean, and accurate: foundations are, like most organizations, chiefly invested in their own interests and thus would rather propagate themselves into the future; Saul Alinski has argued that the only thing that matters in community organizing is identifying the “self-interest” of the those you are trying to organize, and in this case all that matters is the foundations. If they were purely motivated by the public good—which would seem the primary argument against my argument about foundations—they would presumably raise their payout rates.

Is there any way to counteract this dynamic and thus implicitly change the way foundations operate? It seems improbable. Occasionally a foundation may take a principled stand in a fashion similar to the way Harvard recently used its endowment to cut tuition, but the paper by Deep and Frumkin argues that the situation is getting worse, not better. While foundations are only required to give away five percent of their assets every year, the average American stock market indices have increased by, on average, about 11% per year since World War II. There is apparently some pressure to increase the payout rate, but I don’t think this will actually happen.

I’m skeptical because foundations themselves are unlikely to reduce their power and longevity by increasing payouts en masse, and Congress is equally unlikely to do so because the very rich who donate to congressional campaigns would immediately get every Congressman to whom they (the rich people) ever gave money to on the phone and demand that the payout rule be changed back to 5%. Why? Because the very rich tend to be men, and their wives tend to be the ones sitting on nonprofit boards, running foundations, donating to museums, and what not.

The minute Congress tries to alter this arrangement, the wives of whoever endowed the foundation are going to rise up in arms until the status quo is resolved. Isaac pointed this out to me one time when I read in the newspaper that Congress was threatening to cut the National Endowment for the Arts (NEA) funding: he said it would never happen because of just the situation I described, and he was right. The NEA is particularly unlikely to suffer deep cuts because it represents a very small but highly visible part of the government, and besides, it’s only a small part of discretionary social spending, which is dwarfed by mandatory spending, interest, and defense. This, incidentally, is why Alan Greenspan has been running around and talking about why Medicare—not the war in Iraq, or interest, or any number of other things—is the biggest long-term budget problem facing the U.S.

That was a long enough tangent, and the main point remains that since the same people who tend to fund foundations are also the ones who fund Congressional campaigns, it seems unlikely that Congress will tamper with foundations. So, foundations are unlikely to give more unless they want to. But the question of why do funders give remains.

Maimonides was a 12th century Rabbi who said there are eight levels of giving, with the top loosely being those who help anonymously and without expectation of reward and the bottom being those who give miserly or reluctantly and with the expectation of recognition. As you might have guessed, foundations tend to end up toward the bottom of Maimonides’ chain, meaning that they want to perpetuate themselves, put their names on things, and the like. This makes them highly unlikely to want to raise the payout rate and thus endanger their existence.

Now I’ll more fully discuss the second point: how difficult foundations make it to apply for money, as they seem uninterested in improving the grant making process for those requesting the grants. Questions are too often absurd and forms are poorly thought out (a great example of this will be discussed in a forthcoming post). In the fifteen years Seliger + Associates been in business, the number of times we’ve ever been called by funders asking how the process might be improved is zero.

Never. Not once. Proctor & Gamble, Microsoft, Boeing, and virtually every other large company or organization probably spends millions of dollars trying to figure out how to improve its products and services, but foundations do not appear to, or, if they do, they don’t ask the people who are involved in writing proposals. As a result, they raise the cost of acquiring funding and allow a proportionally lower amount to go to actual services, in a tangent phenomenon to what I discussed here.

Arguably, one could say that foundations make it difficult to receive money so the most interested and hence deserving nonprofits end up with funding. The application becomes a signaling device. There is some merit to the argument, but it also implies that foundations would cause nonprofits that are already successful not bother applying and simultaneously waste the time of foundations that do bother to apply by forcing them to play signaling games.

These perverse incentives coupled with the relative power of foundations compared with grant receivers, the vanity of being perceived as charitable, and the lack of discipline imposed on foundations will probably result in foundations of the future that look mostly like the ones of the present. Perhaps a few of them will buck the trend and spend significantly more than 5% per year, but this seems more likely to be the exception than the norm, especially after the initial funders die. After all, if you were running a foundation, would you be inclined to shut its doors and thus deprive yourself of management fees, free travel to study problems/applicant, or social prestige? Maybe you, the individual, would, but the plural you, who run foundations, wouldn’t.

And I haven’t even discussed how tax advantages work.

I don’t perceive much change in the foundation world, just as Isaac hasn’t seen much change in the overall world of grants in his 35 years of experience. In Charlie Wilson’s War (the movie version), Julia Roberts asks Tom Hanks why Congress says one thing and does another and he drolly replies, “Well, tradition, mostly.” The same could be said of the U.S. nonprofit world, and in 30 years I bet the problems and perils of foundation giving and many other aspects of grant writing will be the same they are today.

* As of 2018, it appears that Seliger + Associates has outlasted “New Voices of Philanthropy,” as the URL that used to be here deadends into a spam site. I guess sometimes the old voices endure longer than the new ones.

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