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Economic Analysis of the Nonprofit Sector

Economic Environment Analysis of the Nonprofit Sector

Author's Note: The terms “nonprofit” and “charity” as used in this paper refers to the category of US nonprofit corporations recognized as tax-exempt under IRC Section 501(c)3, with emphasis on those 501(c)3 corporations that are public operating charities. These nonprofits are defined by the IRS as “...religious, educational, charitable, scientific, or literary organizations....[or] organizations preventing cruelty to children or animals.”

Description of the Sector
The nonprofit sector of the US economy encompasses more than 950,000 organizations*, employs more than 8% of the US workforce and accounts for more than 7% of GDP. Participants include hospitals, universities, human and social service agencies, churches and faith-based organizations, “umbrella” organizations like the United Way, and disease-specific organizations (e.g., American Heart Association, Alzheimer's Association), among many other types. The IRS publishes a taxonomy of exempt organizations that lists over 125 different types of 501(c)3 nonprofits by mission and clientele served.

The sector is highly decentralized. Most charities are locally-based, serving a discrete population in a small geographic area with an annual budget under $500,000 and fewer than 5 employees. Only about 10,000 nonprofits in the US have revenues over $10 million, and only 40,000 have revenues over $1 million. In South Dakota, there are 5,375 nonprofits; however, only 67 have revenues over $1 million.

Staff leadership typically has about four years' experience in their current position. Nonprofits are typically governed by a volunteer Board of Directors who provide strategic direction, fund development assistance, are responsible for hiring and evaluating the senior staff person, and are the ultimate accountable authority for the organization. Most nonprofits have a senior staff person known as the Executive Director, CEO, or President. S/he is supported by one or more program directors and workers, clerical/support staff, and bookkeeping/fiscal staff.

Funding to support nonprofits is also highly decentralized. Generally, funding streams break into thirds - Federal, state, and local government grants and contracts; gifts from individuals, corporations, and foundations; and revenue, usually in the form of fees for service. Gifts to charity in 2002 totaled $242 billion, and volunteer hours donated to charity were valued at almost $300 billion. The United Way is one of the largest recipients of charitable gifts, yet only accounts for about 2% of all gifts annually. The huge outpouring of gifts in the wake of the 9/11 attacks in New York and Washington only accounted for a little more than 1% of all charitable gifts made in 2001.

Growth in both funding and the number of nonprofits has exploded since the 1970s (major Federal legislation framing the current state of the sector was passed in the late 1960s), though growth paused in 2001 in response to a sluggish economy. The sector follows business and investment cycles pretty closely, though it is often a lagging indicator by 12-24 months. All gifts to charity account for about 2.2% of GDP, and corporate support follows net profits closely, usually between 1.0 and 1.2% of net profits annually.

The explosion of the number of nonprofits and the growing sophistication of their fund raising methods causes nonprofits to increasingly compete with each other for funding. Sometimes, nonprofits also compete for clientele. Often, competition emerges when a clientele represents a potential revenue source for the nonprofits, though this is not necessarily always the case. Stabilization of funding sources, especially government support, has heightened competition for grants and collaborative agreements.

Some governments are more willing than in years past to consider using for-profit entities to provide, evaluate, monitor, or assess the need for services traditionally provided by nonprofits. Others are trying to curtail grants and contracts, preferring to use their own staffs and facilities to deliver services that were formerly provided by nonprofits. These trends are often cyclical, dependent on political philosophy and availability of tax dollars, especially income tax dollars, in most states.

Lifestyle changes and the explosion of nonprofits to serve have proven to be significant challenges for access to volunteer support. Robert Putnam's Bowling Alone documents the changes in lifestyle, the shrinking time availability, and the “cocooning” of people in homes saturated with technological access to “virtual lives” that have often supplanted regular community-based volunteer contacts. BoardSource estimates that there are over 17 million positions for nonprofit board members alone across the US. Although many people fill more than one board position, it's common for board slots to remain vacant, and for board leadership positions to filled by anyone willing (rather than by competition or by qualification).

The plethora of causes and charities has also served to restrict their free access to media. News releases and PSAs that were routinely covered by local media are now increasingly likely to be vetted, culled, and shunted to late-night TV or small notice in newspapers. Some local media have chosen to ally themselves in a co-branding strategy with particular charities as demonstration of their community focus, further facilitating the restriction of access of other charities (in particular, “competing charities”) to these media outlets.

Direct mail and telemarketing have become increasingly expensive, and are almost cost-prohibitive as a promotional medium. Fund raising appeals are wrapped in and around “informational” messages, and consumers are less likely to respond to such appeals than in the past. Consumers under 45 are less likely to respond to any solicitation from non-local charities, eschewing the American Heart Association in favor of contributing to the neighbor participating in the local Heart Walk.

Analysis of Economic Factors
Some economic factors affecting annual giving have been noted in the “Description of the Sector” section above. The overwhelming long-term economic factor affecting the nonprofit sector is the emerging intergenerational transfer of wealth. Chronological age is the single largest statistical indicator of net worth. The “Eisenhower generation” and the “baby boomers” are estimated to transfer between $20 and $140 trillion between now and 2040 to heirs, the government, and to charities. Indicators of this looming transfer include the rise of asset-funded and life insurance-funded charitable trusts, as well as declared bequests from simple wills.

Estate tax changes may influence the size of the wealth transfer to charities. Currently, the estate tax will be repealed for one year, in 2010, then reinstated. However, there is a push to either make the repeal permanent or, at minimum, increase the dollar amount excluded from estate tax.

Much wealth is tied up in Individual Retirement Accounts (IRAs) and similar plans. These assets are currently subject to particularly onerous estate tax treatment. Attempts are being made to allow for IRA funds to be used to fund charitable contributions without tax penalty to the donor while allowing charitable deductions to be taken. As IRA assets increase through the aging of the population and long-term increase in investment returns, both charities and governments will be looking to these restricted assets as a potential funding source.

Suggestions for the Future
Nonprofits will have to work harder and smarter to secure needed monetary, staff, and volunteer resources to be successful over the long term. Increased media and regulatory attention to large nonprofits in general, and a few scandals in particular, will lead to a need for nonprofits to be especially assiduous in attracting, retaining, and building their capacity to meet increased fiscal and governance accountability expectations. Low barriers to entry for small nonprofits will lead to continued fractionalization of the volunteer and fund raising market for nonprofits, with most of these entities staying very small in resources and impact. Successful nonprofits of all sizes will adopt institutional and programmatic sustainability as integral, and their long-range planning will be made while looking through that lens. Collaboration and cooperation between nonprofits is often sought by funders, but competition, fractionalization of the market, and low barriers to entry by new organizations make significant consolidation impractical. Opportunistic, situational collaborations may be desirable and beneficial in specific situations, and should be sought whenever feasible and not contrary to the general sustainability of the nonprofits involved.

Changing population demographics, giving patterns, and lifestyle choices force nonprofits to adapt their volunteer recruitment/management, fund development, program, and governance strategies. Flexibility and responsiveness to changing markets, with the emergence of a consumer-driven marketing model, will be necessary for nonprofits to meet the new demands of the coming years.

* This figure includes 501(c)3 nonprofits recognized as tax-exempt by the Internal Revenue Service. Churches are not required to be recognized, and many small nonprofits choose not to seek recognition. Therefore, the actual total number of nonprofits may exceed 1.5 million.