“Ring-Fencing” and The Political Science of Tax Exemption
Ring-Fencing is a term accounting people use to refer to the segregation of assets or funds from an otherwise general use. Assets are somehow set aside or exempted. Scott Hodge, Roger Meiners & Andrew P. Morriss use the phrase to describe the effect of tax exemptions in the United States. They demonstrate, by fresh new data, that a lot of money is ring-fenced into the nonprofit sector. They conclude that this is a bad thing, not a good thing. Here is an excerpt from their recently posted article:
In 1909 when some Senators initially expressed concern about the size of the business sector not subject to taxation it constituted just five percent of GDP. By 2019, tax-exempt nonprofit organizations reported nearly $3.3 trillion in income and roughly $3.1 trillion in expenses, which resulted in $238 billion in net income. As seen in Table 1, they commanded more than $8.1 trillion in assets. The tax-exempt business economy is a stunning 15 percent of GDP in the United States, roughly equal to the GDP of California, itself the fifth-largest economy in the world. While the total number of nonprofits is over 1.8 million, Table 1 represents organizations that file a full 990 federal income tax return providing complete financial information, which is about 400,000 entities. The size of the non-profit sector is undoubtedly larger when the other 1.4 million entities are considered as well.
The strength of the article is in the data. The article includes sections on the wealth ring fenced into the largest exempt sectors: (1) health care, (2) education, (3) research organizations, and (4) credit unions. Of those sectors, only credit unions present a real case of inefficient tax exemption, even from a purely economic standpoint. By inefficient, I mean undeserved, unnecessary, or costing more than its worth. Economists define inefficiency only by reference to third definition — costing more than its worth — and even here there is not enough in the authors’ analysis to make the case except perhaps with regard to credit unions. Banks do pretty much exactly the same thing as credit unions.
The authors don’t offer much more by way of argument against tax exemption – ring fencing – that has not already been made. Principally, they assert that organizations supported by fees and prices, rather than donations, should not be exempt because they are no different from taxable organizations. Never mind that the former is subject to the prohibitions against private inurement and excess benefit. They cite Mark Hall & John Columbo’s piece arguing that tax exemption should be limited to nonprofits supported by donations rather than fees or prices. And they bolster the argument by citing to Kaplow and Shavell. Stanley Surrey and George Yin are thrown in for added indignation regarding “special provisions” in the tax code benefitting just a few and increasing everybody else’s tax burden.
They conclude by repeating the familiar argument that all that untaxed wealth could instead go to the government which would, presumably, use it for public benefit. I don’t dispute the conclusion nor is my counter argument that private entities are invariably better at managing public wealth or pursuing private benefit than the government.
What’s missing from the purely economically-minded authors is the political science point. Tax exemption, even if less efficient than government-defined and dispensed public good, allows for minority participation in the definition and dispensation. Political minorities, I mean. People who are unable to garner enough votes so that government pursues their conception of the public good. Government represents the center. By nature, the center’s definition and dispensation will exclude ideas and preferences of those on the margins. If the tax base represents all the commercial profit derived by market participants – nonprofit and for-profit – what’s wrong with allowing both the majority and the unorganized minority to share in the decisions by which the taxes are put to public use? What’s wrong with reserving 15% of GDP for use by the grass root organizations seeking more input into definition and dispensation of the public good? Maybe doing so provides for more, not less, participatory government.
The authors don’t address that question. They might argue that too often the portion left to the grass roots unorganized portion is actually diverted to private benefit. They don’t and even if they did, that problem might be better resolved through legislation rather than government levy on 100% of the tax base.
darryll k. jones