Mises Daily

How Non-Profits Enhance Freedom and Markets

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[Editor’s Note: Non-profits are often wrongly characterized as being “creations of government” that arose only as a response to the tax rules. In this Mises Daily article from 2006, Karen De Coster defends non-profits on historical and philanthropic grounds.]

Nonprofit organizations play an integral role in a free market economy. The establishment of a voluntary nonprofit organization is not merely an exercise for obtaining tax-exempt status for wealth protection within a burdensome tax system, though that is a splendid end in its own right.

Instead, nonprofit organizations are concerned with generating explicit betterments of all types, on a volunteer basis — including such inclinations as the advancement of ideas, the promotion and safeguarding of cultures and religions, charitable giving, and the guardianship of historical treasures.

Within the profit sector, firms are motivated to be streamlined and efficient so that profits can be distributed to their owners and investors. The nonprofit, however, has other motives. It is a voluntary membership organization that exists to attain some defined purpose and devote its funds and resources to the maximization of those ends that its members and benefactors desire to attain. This is accomplished on a no-profit, no-loss basis. A nonprofit organization gets tax-exempt status with the IRS because its members do not benefit financially from any profits.

Indeed, there are those who argue that everything should be for-profit, and that the IRS created nonprofits in effect. This is not accurate. There have always been nonprofits such as religious institutions, universities, hospitals, shelters, orphanages, etc. Rather, the government – through its regulation and taxation policies — has distorted the market to the point where business organization and motives became ever changing in order to stave off the negative effects of massive theft and bureaucracy.

And thus the IRS, in an attempt to soften the damaging consequences upon the sector that engaged in philanthropic ideals, offered up the nonprofit status, or tax escape. Like the “enterprise zone” hoax and other tax incentives, the tax-exempt status is an attempt at social engineering through “kinder and gentler” theft policies. So the IRS did create the tax status effect of nonprofits, but not the concept itself.

Nonprofit, of course, is not equated with losses, but instead is based on a break even concept so that those who run the organization can concentrate on carrying out its stated goals without having to supply financial gain to those who fund the organization. It is the organization’s leaders, along with donors and members, who voluntarily coalesce toward a similar vision, whether or not the results can even be accurately measured. In writing about nonprofit foundations, Dr. Randall G. Holcombe notes:

Foundations have increasingly devoted their resources toward preventing problems from occurring in the first place. This line of reasoning has led foundations to devote considerable resources toward developing social science, and toward analyzing public policy issues. Foundations have expanded from charity, narrowly defined, into the world of ideas. By nurturing the ideas that can make the world a better place, everyone can benefit.

He goes on to say, “it is more difficult to evaluate the efficacy of ideas than the efficacy of charitable giving, which raises the question of the degree to which foundation funding of ideas actually makes the world a better place.”

Holcombe is spot on, though the assessment of efficiency is a different topic for another time and place. In Self-Renewal: The Individual and the Innovative Society, John W. Gardner observes the market for ideas:

The [nonprofit] sector is a significant source of renewal. An idea that is controversial, unpopular or strange has little chance in either the commercial or the political marketplace. ... The sector comfortably harbors innovators, maverick movements, groups which feel they must fight for their place in the sun, and critics and dissenters of both liberal and conservative persuasion. And it is from just such individuals and groups that one may expect emergence of the ideas that will dominate our society and our world a century hence.

That brings us to perhaps the most commendable trait of the nonprofit sector: it consists of voluntary coalitions and partnerships of individuals who have decided to take up a noteworthy cause, and hence, may replace what otherwise might be public sector advancement into that particular domain. After all, the powers-that-be deem particular goods or services to be necessary to a democratic society, and if the provision for these goods and services is not taken up voluntarily by entrepreneurs, in a nonprofit operation, the government will likely step in and tax the private sector in order to fund the provision of them as public goods. In that case, political lobbying, partisan interests, and other unpleasant exploits are much more likely to have a negative influence on the outcome of the stated goals.

The recipients of nonprofit services reap substantial benefits from their operation, including that which is derived from scholarly think tanks, educational institutions, health organizations, family and religious organizations, cultural-ethnic societies, historical preservation societies, and those unconventional organizations that assist people with disabilities or place homeless pets into good homes. The individuals who benefit from charitable nonprofits have less autonomy when such services are the result of government subsidies and welfare arrangements.

Thus we may think of a coalition of philanthropists and goal-oriented volunteers joining together to stave off further encroachment of the welfare state. While it’s true that many nonprofits — mainly those with social welfare agendas — may gain from government grants, nevertheless, nonprofits serve as a bulwark of the free market when forestalling the initiation of more public goods and centralized welfare planning.

In addition, those who fund nonprofits or provide voluntary services typically exude a great passion for that into which they voluntarily sink their time, effort, or money. The satisfaction of deeds well done or the achievement of objectives is unquestionably a motivating factor for humans who strive to meet philanthropic ideals. Perhaps the most noble aspect of the rewards received by way of a nonprofit organization is that when it comes to private funding, no one individual is forced to pay for an outcome or benefit of which he does not approve. People who do not endorse a nonprofit’s activities need not interact with that organization.

The separation of “non-profit” and “for-profit” sectors is an admirable notion. For individuals who are not out to earn a return on investment and who want to invest in the chosen, non-monetary objectives of an organization, the nonprofit allows them to contribute to those desired outcomes. A psychic profit, perhaps, is as important to some as a monetary profit. These non-monetary gains are essential for the “good life” enjoyed by those living under a free, bourgeois system. After all, certain services that cannot be easily turned into monetary profits benefit from the financial support of voluntary parties as well as the lack of an IRS boogeyman stealing the profits.

In fact, as Murray Rothbard noted in “The Myth of Neutral Taxation,” the nonprofit benefactors and members are, in essence, both the investors and consumers. How is that so? Rothbard explains:

In a sense, then, the members are the “consumers,” except that they consume the services of the organization not by purchasing a product but by helping the organization pursue its goals. The member-donors are at the same time the consumers and the investors, the consumers and the makers of the production decisions.

... Even where the explicit goals of the organization are to help non-donors, this rule — that the consumers guiding production decisions are the donors — still applies. Suppose, for example, the organization is a charity giving alms to the poor. In a sense, the purpose is to benefit the poor, but the actual consumers here, the guides to production decisions, are the donors, not the recipients of charity. The charity serves the purposes of the donors, and these purposes are in turn to help the poor. But it is the donors who are consuming, the donors who are demonstrating their preference for sacrificing a lesser benefit (the use of their money elsewhere) for a greater (giving money to the charity to help the poor). It is the donors whose production decisions guide the actions of the charity.

The characteristics of the nonprofit economy are such that government both encourages and discourages nonprofits through subsidies and restrictions, while proclaiming the virtues of some, and conveying skepticism toward others. In a true free market economy, the government would have no bearing on the formation, mission, or social outcome of any organization, whether profit or nonprofit.

In fact, in a perfectly free market setting, there would be no redistributive tax schemes, and thus no need for the special creation of a favorable tax environment within the nonprofit framework. However, in the celestial throne of Leviathan’s regulatory and tax state, the nonprofit is a small escape hatch for those wishing to gain as much advantage as possible while losing as little as possible to the corridors of power.

True, nonprofit organizations reside in a “hidden” sector of our economy — one where scant attention is sometimes paid. Indeed, all of our lives are touched in some way by an array of nonprofit organizations working toward carrying out defined goals in voluntary, non-coercive ways. The nonprofit form of enterprise is indispensable to both recipient individuals and the benefactors who fund them.

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