Observing Nonprofits :: July 29, 2002

The Evergreen State Society

Observing Nonprofits

July 29, 2002

A Thousand Points of Contention:
Property-Tax Exemptions for Nonprofits in the United States

A review with an eye toward Washington state
by Putnam Barber, President, The Evergreen State society

One of the sources of the nonprofit sector’s enduring interest is that what “everyone knows” so often turns out to be characterized by elusive data, policy conundrums, and enormous variation in the ways things are done.

Property-tax exemptions are a case in point. Editor Evelyn Brody and the 18 papers brought together in Property-Tax Exemption for Charities: Mapping the Battlefield (Urban Institute, 2002) carry the reader a long way in their approaches to describing how things work on the complicated frontier between local government revenues and the land, buildings and equipment owned by nonprofit organizations. But, as many of them observe, there are still plenty of unanswered, perhaps unanswerable, questions about the topics of interest that arise as soon as the subject is opened to scrutiny.

Property taxes are, relatively, easy to collect, especially because such tangible objects are hard to conceal -- or “export” to other jurisdictions. Hence the strong interest by local governments in protecting their tax base, and the strong interest among property owners in finding ways to limit, or avoid entirely, having taxes applied to their assets. The political ingenuity called forth by this contest of interests is impressive. These battles take place, most of the time, in village halls, town meetings and city council chambers within constraints enacted by legislatures and popular initiatives; they are tempered by judicial decisions of courts of every sort. The end result is a confused jumble. The success of these authors in sorting out some of the mysteries makes for fascinating reading. And offers a cautionary lesson to anyone who believes that making policy can be simple or that the results can easily be predicted.

It’s probably safe to say that in nearly every jurisdiction in the United States, some nonprofit organizations are not required to pay some of the taxes that would apply if their property were under other ownership. There are, though, no reliable data on which to base an estimate of the revenue forgone by these taxing districts or the related effect on the finances of the benefiting organizations. In Chapter 4, “What is the Property-Tax Exemption Worth,” Joseph J. Cordes, Marie Gantz and Thomas Pollak explore several methods of estimating an answer and conclude with “an estimated aggregate value of the property-tax exemption of between $8 and $13 billion nationally, representing between 1.3 and 2.1 percent of the total revenue received by…nonprofits…in 1997.”

Washington’s Department of Revenue estimates the effect of the exemptions that apply to taxpayers in the state. In the 1997-99 biennium, nonprofit organizations did not pay about $270 million in property taxes each year compared to total revenue (for those required to file financial reports with the federal government) of over $12 billion, putting the state at the upper end of the range of estimates of the financial benefit from this exemption. Lest these large numbers support a common misconception, it’s important to put things in perspective by noting that the same Department of Revenue report shows that the exemptions received by nonprofit organizations under state law are just 2.6% of the total of all such exemptions the legislature has granted. (These statistics, and the difficulties with the underlying data, are discussed in more detail in Nonprofits in Washington: 1999, published by The Evergreen State Society.)

Economists and policy-makers agree that part of the property-tax bill should be understood as a fee for specific municipal services. In Seattle, everyone pays a separate water bill to the city-owned utility; in Sacramento, the city provides water to every parcel and there aren’t even any meters. Part of the local tax there pays for the water people use. Analysts don’t agree, though, on the rationale for having some exemptions from property-taxes, whether the exemptions extend to the entire tax bill or try to separate out the part that goes toward general-purpose government from the portion that is best understood as fees for services provided by the city.

Peter Dobkin Hall’s essay looks back to 18th century New Haven, and points out that many services that are provided to us by municipal governments were in Colonial times provided by precursors of our present-day nonprofits: generally church congregations, but also institutions formed for specific purposes (like Yale University). This pattern suggests that the tax exemption for such groups was “contingent” on the services provided, not “intrinsic” to their “nonprofit” status. In fact, he argues, that distinction among types of organizations would not have been recognized by political thinkers of the time.

Janne Gallagher generalizes this key observation. “It is important to keep in mind,” she writes, “that the development of the state charitable-exemption law predated the adoption of the federal Internal Revenue Code, and that property-tax exemption, rather than being derived from federal law, was the basis for many of the concepts that found their way into the income-tax regulations and rulings.” Churches, libraries, hospitals, nursing homes and orphanages were recognized as exempt from property taxes in Washington state well before the passage of the federal income tax; art and history museums, colleges and “nonsectarian charitable organizations” were added to the list after passage of the federal tax code made the distinction between nonprofit and for-profit corporations more salient.

Once you start looking closely at the property tax, as the authors of this book help us to do, two quite different rationales emerge for exempting nonprofits -- at least some of them -- from assessments. One -- the “contingent” view -- holds that nonprofits earn their exemptions by “reducing the burdens of government” and offsetting expenditures that would otherwise be made from tax revenues. The other sees nonprofits as intrinsically exempt from taxation, either because of the worthy nature of the work they do or because taxes are legitimately imposed only on income-producing activities and nonprofits, by definition, do not exist to generate income. (Peter Swords’ “commentary” in the present volume develops fully the case for this last point of view.)

If it is possible to draw out any consistent rationale for the way Washington state has structured property-tax exemptions for nonprofits, it would probably fall in the second category. The state’s constitution requires that all property be assessed at the same rate but permits the legislature to specify property that will be exempt from taxes. The list of exemptions the legislature has authorized includes the familiar sorts of institutions -- generally churches, schools, hospitals and museums, as mentioned -- and some remarkably specific instances such as dialysis facilities and the offices used by federated fund-raising organizations. (One suspects that such specific cases were added to the list when the Department of Revenue denied exemption to an institution with a strong claim that its work was at least as worthy as that of some others whose exemptions had not been challenged.)

The property-tax regulations in Washington allow the taxes to be prorated when part of a building is used for a non-exempt purpose and part is clearly exempt. Museum and hospital gift-shops are often treated in this way. The part that is clearly exempt, though, must be used “exclusively” for the tax-exempt purpose. Inattentive nonprofits get into trouble over this point all the time. Churches have their exempt status challenged when they lease their parking lots for weekday use by commuters; museums find that letting businesses and private individuals rent spaces for meetings or weddings can call into question the exemption for the whole building.

Contrast the rule in North Dakota, which is described in Janne Gallagher’s chapter, where a camp was allowed to pro-rate a reduction in its taxes based on the number of days in the year it was used for exempt purposes (religious education). The financial situation of Washington nonprofits would be made more secure, important community spaces in churches, schools and museums would be more available for all sorts of uses, and overall tax revenue would likely increase, if Washington’s policymakers could arrive at a straightforward formula for allowing a similar practice here.

Because commercial uses are so clearly not exempt from property-taxes in Washington, even when conducted by nonprofit organizations, we are spared one version of the political friction around “unfair competition” that is prevalent in some other jurisdictions. Fortunately, too, the fiscal challenges faced by local governments here have not led to any strong calls for scaling back nonprofit property-tax exemptions or for the establishment of payments in lieu of taxes (PILOTs) as a way to supplement municipal revenues. In some jurisdictions on the east coast (New Haven, Baltimore, the state of Pennsylvania), such attempts have been called “extortion” by nonprofit leaders while inspiring bitter and sustained attacks on nonprofit “privileges” from tax-reduction advocates and some local officials.

In the late 1990s, there were nearly 40,000 nonprofit corporations registered with Washington’s Secretary of State -- not counting the many religious organizations that are not incorporated. At about the same time, there were less than 7,900 nonprofit organizations -- including 4,578 churches -- that had been granted exemption from property taxes after application to the Department of Revenue. Several of the authors of chapters in Property-Tax Exemption for Charities comment on the contrast between the intellectual and political interest the topic generates and the relatively small numbers of organizations who are actually benefited by property-tax exemptions. The ones to which exemption matters the most are, of course, institutions whose programs depend on the use of substantial property -- churches, private colleges, homes for the battered women and the aging, hospitals, museums and art galleries, research laboratories, shelters for the homeless. Most nonprofits own little or no property; they have no facilities at all or operate out of rented space. Changes in property-tax exemptions are unlikely to touch these organizations for better or for worse. But, as many of the authors in this fascinating collection of essays point out, the effects on the ones that would be affected could be very significant indeed. And those institutions are, here in Washington and in other communities across the country, the landmark nonprofits that define and sustain critically important elements of our culture and welfare.

To order a copy of Property-Tax Exemption for Charities: Mapping the Battlefield visit this link at Amazon.Com:

http://www.amazon.com/exec/obidos/ASIN/0877667063/internetnonprofi

If you use this link, a royalty will be paid to The Evergreen State Society based on your purchase. Thank you!

Property-Tax Exemptions for Charities: Mapping the Battlefield. Evelyn Brody, ed. Washington, DC: The Urban Institute Press, 2002.

Table of Contents:

Introduction - Evelyn Brody

PART I: Framework and Structure

1 The Legal Structure of Property-Tax Exemption - Janne Gallagher

2 The Politics of the Property-Tax Debate: Political Issues - Joan M. Youngman

3 Local Government Finance and the Economics of Property-Tax Exemption - Dick Netzer

4 What Is the Property-Tax Exemption Worth? -Joseph J. Cordes, Marie Gantz, and Thomas Pollak

PART II: Contrasting Theories of Exemption Law

5 Efficiency and Benevolence: Philanthropic Tax Exemptions in 19th-Century America - Stephen Diamond

6 Legal Theories of Tax Exemption: A Sovereignty Perspective - Evelyn Brody

7 The Special Case of Churches - Deirdre Dessingue

PART III: The Economic War within the States: Exemption Battles and PILOTs

8 PILOTs: The Large-City Experience - Pamela Leland

9 PILOTs: Philadelphia and Pennsylvania - David B. Glancey

10 PILOTs: Hartford and Connecticut - Nicholas R. Carbone and Evelyn Brody

11 Is Tax Exemption Intrinsic or Contingent? Tax Treatment of Voluntary Associations, Nonprofit Organizations, and Religious Bodies in New Haven, Connecticut, 1750-2000 - Peter Dobkin Hall

PART IV: Exploring Future Directions

12 Impact Fees: An Alternative to PILOTs - Woods Bowman

13 Targeting the Charitable Property-Tax Exemption to Collective Goods - Robert T. Grimm, Jr.

Commentaries

1. Property-Tax Exemption for Charities: The Minnesota Experience - Daniel Salomone

2. A Public-Choice Approach to Explaining Exemptions and PILOTs - David L. Sjoquist

3. Reform as Preservation - Edward A. Zelinsky

4. The Charitable Real Property-Tax Exemption as a Tax Base-Defining Provision - Peter Swords

5. The Collision between Nonprofits and Cities over the Property Tax: Possible Solutions - Richard D. Pomp