Nonprofits in the American Economic System

Jane Addams' Hull House

INTRODUCTION AND ISSUES

Nonprofits are the third part of the American economy and society but discussed less often. About 1.6 million nonprofits accounted for about 12.3 million paid employees in 2016, more than 10.2% of the entire workforce. Nonprofits sold about $940 billion of goods and services in 2014, about 5.4% of GDP. Some of the goods and services of nonprofits are given away; they are considered transfer payments and not counted in GDP.  Total revenue, including imputed value of donated goods and services of nonprofits was $2.01 trillion in 2015, about equal to the total revenue of all state governments. 

Employment and charitable giving data indicates that nonprofit revenue continues to grow.

Private charitable giving in 2018 is expected to be around $410 billion. The average household's cash contribution is around $2,100.

  

Have you ever:

Gone to a private school or college?

Entered a nonprofit hospital?

Attended a cultural event such as a concert, museum or play?

Watched a public TV channel or listened to a public radio station?

Belonged to a church?

Been active in an environmental group?

Belonged to a “Y?”

Belong to a fraternal club or organization?

This is only a sample of the many specialized goods and services nonprofits provide. 

Until recently, nonprofits have been peculiarly American phenomena.  One source has been evangelical Protestantism.  Starting with the Second Great Awakening of the 1820s-1830s, born-again Protestants and others have been exhorted to struggle against social evils and improve society.  Religious groups like the American Bible Society (still in existence) printed and distributed Bibles and other religious material to spread the Gospel on the American frontier and abroad through missionaries. Out of this impulse came many of the 19^th century reform movements, including abolition, suffrage and temperance (later Prohibition).  Ken Burns’ documentary on Prohibition emphasizes how the highly organized Anti-Saloon League was able to tap into native-born Protestant beliefs and organizations to amend the Constitution to abolish alcohol, an extraordinary accomplishment.

It is hard to imagine any other country funding the development of a polio vaccine through the March of Dimes. Or the huge amount of medical research funded by charitable giving. Every disease or medical problem seems to have a targeted nonprofit dedicated to its eradication or control.

Unlike other countries until recently, many of America’s wealthiest individuals and families have given away most of their fortunes or continued to support nonprofits through foundations.  A personal note:  The small town I grew up in had a Carnegie library, the most imposing building in town.  If it weren’t for that library, I would probably have ended up picking oranges in the nearby Sunkist orange groves. 

        

Before 1945, most of America’s colleges, hospitals, museums and major cultural groups were started and funded by private philanthropists. As far back as the 1830s, de Toqueville commented on the puzzling American behavior of forming private, volunteer organizations to attack a perceived public problem or start a socially beneficial institution.

Open software companies are an interesting new type of nonprofits. They have also generated new opportunities for for-profit companies that offer value-added software and support. This is another example, like for-profit hospitals and colleges, where nonprofits have developed a new market and for-profits attempt to find profitable niches. 

Social and political reform movements continue to proliferate outside of the political party structure. There are an incredible number of similar groups today; I seem to be on all of their mailing lists.

Nonprofits are decentralized, local providers of social goods and services. This may be more efficient than a system of centralized governmental organizations.

WHAT IS A NONPROFIT?

The name is somewhat misleading.  Nonprofit doesn’t mean that the organization doesn’t make an accounting profit (revenue greater than costs).  Like any organization, it must at a minimum cover its costs, like a for-profit, and generate a profit for growth and capital investment.  

The big difference is that nonprofits do not pay some taxes – Federal income taxes, state income taxes, sales taxes and local property taxes.  They do pay other taxes, such as payroll taxes (Social Security, Medicare, disability, unemployment). The other major difference is that less than half of revenue comes from the receivers of nonprofit goods and services. Even when paid by customers, much of the customers' expense is ultimately paid by third-party payers.

Some private contributions and donations are tax-deductible.  This mostly benefits corporations and higher-income households who itemize deductions. Under the new tax laws, only about 5% of all households itemize deductions. Wealthy individuals and families also set up foundations and other nonprofits to create wage income and to avoid inheritance taxes.

Larger, well-known nonprofits like large hospitals and private universities can market tax-exempt bonds at lower interest rates.

So the main difference is that  “nonprofits” are primarily “non-taxed.”  In exchange, nonprofits provide “community benefits.”  To an economist, this is a fuzzy and arbitrary legal distinction.  Some communities agree.  Princeton residents are suing Princeton University, contending that some of the University’s policies (sharing patent royalties with faculty) constitute for-profit operations and the University should lose its nonprofit status.  Pittsburgh challenged the University of Pittsburgh Medical Center’s nonprofit status. The new mayor dropped the suit in exchange for the city’s hospitals and Carnegie-Mellon University negotiating with the city to find “areas of mutual interest.”

What do nonprofits do?

Deal with the negative externalities of a capitalist industrial economic system.

Analyze and lobby to ameliorate social and environmental problems.

Deal with the consequences of inequality and poverty in the economic and political system.

Fund high-risk activities, like specialized medical research.

Provide social goods, which probably become more important as the real price of profitable goods become relatively less expensive.

If nonprofits sometimes perform services government doesn’t, they also develop markets for services that are not a government monopoly.  For-profit companies then look to the potentially profitable niches of these markets.  Two examples:  

Hospitals in the suburbs.  

Professional degrees for adult college students (University of Phoenix).

Many nonprofits compete with for-profits and government institutions, such as in the areas of health care, education, entertainment, and culture.

WHY DO NONPROFITS EXIST?

A paradox. Why are there so many nonprofits in an economic system driven by the desire to maximize income and earn profits?  According to the assumptions of economic theory, they should not exist. If you read any economics textbook, they do not exist.

Why are so many people willing to work for nonprofits when they could make higher incomes and benefits working at for-profits or in government?

         Why do people volunteer their time, knowledge and services?

Why do people contribute money and time to nonprofits from which they receive no direct benefit?

All of this widespread behavior implies that decisions on how people earn an income, spend their money or use their time is more complicated than the assumptions made in economics.

SPECIAL CASE:  NGOs

Global Non-Government Organizations (NGOs) are taking over some of the goods and services provided by national governments.  One reason is that sovereign nation-states do not want to pay for supra-national goods and services.  Another reason is that many poor or “failed states” countries will not or cannot afford to provide basic services.  Some problems can only be analyzed or attacked on a regional or global basis and governmental institutions have not been established to do so.  One example is Doctors Without Borders, which has an operating budget of over $400 million.  Many environmental groups are global.

NONPROFITS A GROWING PART OF THE ECONOMY

Between 2001 and 2011, the number of nonprofits increased by 25%.  The number of for-profit businesses increased by one-half of one percent. This is a function of increased demand and need in the areas of health care, child care and care for the elderly, environment, and education.These numbers come from the Urban Institute.  (Somewhat worrisome, the number of for-profit companies in the U.S. has been decreasing since 2008.)

Like the for-profit sector, the nonprofit sector is concentrated. About five percent of nonprofits account for 87% of total revenue and expenses. Nonprofit organizations with revenue over $50 million account for about 75% of total revenue. 

Revenue is also highly concentrated by type of institution.  Health care organizations take in 60% of total nonprofits revenue (hospitals alone – 50%) and private education an additional 17%. (National Center for Charitable Statistics, “Quick Facts About Nonprofits.) But about 66% of all nonprofits have budgets of less than $500,000.

  

GDP and employment figures do not include the number of volunteers or value of goods and services not paid for by recipients.  The Urban Institute estimates the value of volunteers at about $170 billion a year.  (The New York Times, “For Nonprofits, A Bigger Share of the Action, 3/9/14.”)

Some reasons for the growth in the number of nonprofits:

As the population ages, there has been a large increase in the demand for health care services.  Many of these are provided by nonprofits.

The number of charities has grown as the number and problems of the poor has increased during and after the Great Recession of 2007-2009. 

Growing demand for the goods and services provided by nonprofits such as in the areas of education and cultural goods and services.

Many areas of the economy are considered unprofitable or too risky for for-profits.

Government programs don’t exist or are limited by resources or politics. Governments are willing to "outsource" management of what are government goods and services in most countries to private organizations.

Creation of new groups to publicize and combat new social, political and economic problems, such as pollution and protecting the environment. In economic jargon, nonprofits exists because individuals and private groups have organized to publicize and reduce the social costs of a rapidly changing industrial society.

Increased awareness that many of society’s problems can only be attacked on a regional or global scale (beyond national borders) and that there are no international agencies to address them. 

HOW ARE NONPROFITS FINANCED?

Government programs, government subsidies, private donations, private foundation grants, payment for services.  Fees for services (tuition, private health insurance, ticket sales, etc.) account for about 50% of total revenue.  Government grants and payments account for another 32%, or about $550 billion.  Private contributions are the source about $350 million. One-third of private contributions go to religious organizations.

NONPROFITS AND MANAGEMENT

Based on my experience in both corporate life and involvement with a number of nonprofits, I believe that it is more difficult to manage a nonprofit than a similar size department, division or the whole company of a for-profit company.  

Managers in the hierarchy of a for-profit have the tools, incentives and authority in a “command and control” hierarchical structure often missing in a nonprofit.  Managers of a nonprofit often don’t have the threat of firing employees, especially volunteers, or the incentives of promotion, big raises or stock options. 

In nonprofits, there is often a need for consensus, which takes social skills many corporate managers lack. The boards of nonprofits often take a more active role in managing and monitoring managers than in for-profit companies.  Nonprofit managers often lack the resources and have less of the support structure that corporate managers take for granted.  Nonprofit managers must routinely be more “entrepreneurial” than corporate managers.

NONPROFITS AND EMPLOYEES

The existence and growth of nonprofits may also indicate that people work for more complicated reasons that economics assumes.  Nonprofits offer managers and employees opportunities for autonomy (less command and control from above; more independence), mastery and growth (improving skills and knowledge that matter) and purpose (wanting to provide service to others – objectives beyond the individual).   All this suggests that individuals can derive satisfaction on the supply side by working at jobs and for organizations they consider meaningful, rather than just working for a paycheck.

SUMMARY:  NONPROFITS IN A CAPITALIST ECONOMY

In the capitalism vs. socialism debate, nonprofits represent a third way to organize economic activity. Nonprofits have no owners (no shareholders), indicating that private (non-government) companies can be formed without private ownership. Also, profit is not the primary motivation in starting a nonprofit.

Nonprofts are a viable organizational form for a service economy. The growth of nonprofits as a percent of the economy may reflect the shift in demand towards services as health care, education, organized religion, concern with social and environmental problems, cultural institutions, local issues, and funding special interest groups and their projects.

Much of the revenue of nonprofits comes directly or indirectly from tax money. This allows government to pay for programs without actually managing them as in a socialist economy. Much of government-funded basic research and health care services are done in nonprofits. This reduces the costs of bureaucracy and adds flexibility, as many nonprofits are local or deliver specialized services.

Nonprofits develop new markets. For-profit companies then look for profitable niches such as suburban hospitals, career/adult private colleges, and drug development based on basic research. In addition, for-profits provide a wide variety of services to nonprofits.

CONCLUSIONS (FOR ECONOMISTS)

Nonprofits will continue to be a larger part of both the national and global economy as the social costs of production and consumption grow exponentially, as populations age faster than the revenue of government programs, as dysfunctional governments cannot cope with technological change or even provide basic services, and as environmental and social problems further transcend national borders. 

If you believe the basic assumptions of economic theory, it is strange that nonprofits exist at all because they embody much non-economic behavior.  People are willing to work for less money.  They become volunteers and donors, motivated by altruism, social conscience, sociability, empathy, or a sense of fairness.  In short, nonprofits are based on different value systems.

Economists ignore nonprofits because it would require a richer set of psychological motivations than the simple assumptions of economic theory.