Sometimes an action that is intended to have a positive effect, when put into practice, can have the opposite outcome. An article in the March 25, 2009, New York Times talks about a good example of this—the two-tiered federal excise tax for private foundations. While intended to spur foundations to pay out more in grants by giving an incentive in the form of a lower 1 percent rate on foundation investment income and realized gains, versus the previous 2 percent flat tax rate, it does the opposite.
Without delving into the legal nuts and bolts of the excise tax, suffice it to say that in order for a foundation to continue to qualify for the lower rate year after year, it must annually raise the percentage of assets that it spends for grants and expenses. So far that sounds good, but in the long run, it leads to less money for grants because the foundation, in effect, spends down its endowment.
In order to correct for this “bracket-creep” or ever increasing payout rate, every five years or so a foundation that strives to exist in perpetuity, in accordance with the wishes of its benefactor(s), may find it advantageous to reduce the amount it spends in that particular year. By so doing, it purposely pays the higher 2 percent tax rate but makes meeting the requirements for the 1 percent rate easier in the future.
The confusing and complicated nature of these rules adds to the administrative burden on foundations, particularly smaller ones that are more leanly staffed. Foundation managers and their auditors spend considerable time managing this tax issue, diverting more time and money from the organization’s mission.
For all of these reasons, and most of all to accomplish the original, worthy goal of spurring foundation giving, it makes sense to go back to a single rate tax structure. The rate can be set at some level between 1 and 2 percent that would raise the same amount of revenue for the U.S. Treasury. This would produce the desired result.