The Immortal Foundation

Ray D. Madoff, writing in this morning’s NY Times, laments the news that Leona Helmsley bequeathed most of her $8 billion fortune to a foundation dedicated to the care and welfare of dogs:

The charitable deduction constitutes a subsidy from the federal government. The government, in effect, makes itself a partner in every charitable bequest. In Mrs. Helmsley’s case, given that her fortune warranted an estate tax rate of 45 percent, her $8 billion donation for dogs is really a gift of $4.4 billion from her and $3.6 billion from you and me.

To put it in perspective, our contribution to Mrs. Helmsley’s cause equals approximately half of what we spend on Head Start, a program that benefits 900,000 children.

What will we get for our $3.6 billion? An eternal monument to Leona Helmsley’s generosity toward dogs.

First off, why all the canine hate?  Okay, so it’s true that few of us share Leona’s priorities, or at least her apparent enthusiasm.  But I don’t share all of the federal Government’s priorities either.  At the risk of getting political - would you rather than $3.6 billion be spent for the care and welfare of dogs or to buy bombs that will be blown up somewhere in the middle east?

This is the beauty of the charitable deduction.  It decentralizes decisions about which public services are most deserving of support.  Sometimes people make bad decisions.  Sometimes they accomplish brilliant, ambitious things that would never come out of government (witness the Bill and Melinda Gates Foundation).  If you believe in the power of markets and the wisdom of crowds, then you believe that, in the aggregate, this is an efficient way of ensuring that society’s concerns are addressed.

Of course, there are limitations.  These are defined by Section 501(c)(3) of the Internal Revenue Code.  As explained on the IRS website:

The exempt purposes set forth in section 501(c)(3) are charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals.  The term charitable is used in its generally accepted legal sense and includes relief of the poor, the distressed, or the underprivileged; advancement of religion; advancement of education or science; erecting or maintaining public buildings, monuments, or works; lessening the burdens of government; lessening neighborhood tensions; eliminating prejudice and discrimination; defending human and civil rights secured by law; and combating community deterioration and juvenile delinquency.

(Notice that preventing cruelty to animals is expressly mentioned, so Leona’s gift seems unambiguously within established guidelines for charitability.  Also notice that there’s nary a mention of the arts…  That’s right, we fall under “education”, a seemingly precarious position that makes me nervous whenever I contemplate it!)

So Madoff’s pretty misguided on this point. However he raises another issue that deserves to be taken very seriously:

Most such foundations perform no charitable work but only give money to organizations that do. The law requires foundations to spend a minimum of just 5 percent of their assets a year, thus helping ensure their perpetual existence, and their donors’ immortality. In meeting this requirement, foundations are allowed to count fees paid to their trustees and other administrative expenses.

In 2003, legislation was introduced in Congress that would have required private foundations to devote the full 5 percent to charitable expenditures. But the foundations complained that this would threaten their perpetual existence, and the bill did not pass.

Some people who establish perpetual charitable trusts may assume that their philanthropic dollars will go further if the trust distributes only its investment income and preserves its principal. Anyone familiar with the story of the goose that laid the golden eggs knows the importance of not spending principal. However, because a dollar spent today is worth more than a dollar spent several years from now, in many cases, the sum of payments made over time — even in perpetuity — never equals the value of the original principal.

Anyone with the most rudimentary understanding of finance knows that he’s right.  The financial math leads inescapably to the conclusion that private foundations would be maximally effective if they gave away all of their assets within their first year of giving.  Of course, this reasoning fails to consider that wiser giving decisions will presumably be made if there’s a little more time to make them.

So where is the middle ground?  Reintroducing (and passing) that 2003 legislation would be a good start.  By requiring that operating expenses be above and beyond the 5% minimum annual payouts, you ensure that the more efficient (or less profligate) a foundation is, the better shot it has at immortality.  Another approach would be to benchmark the minimum payout threshold to investment returns, thereby ensuring that the foundation’s endowment doesn’t outpace its giving.