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A proposal to overhaul tax-exempt law

House Oversight Committee listens to law professor's ideas with an open mind

It was like a skunk at a garden party, and to a large segment of the tax-exempt sector, the testimony at this summer’s congressional hearing had to have been odiferous.

The testimony was that of University of Illinois law professor John D. Colombo. He told the House Oversight Subcommittee it should consider taking away the tax exemptions of most of the biggest charities in the country, including almost all the non-profit hospitals and universities. The congressmen did not reject his suggestion out of hand, nor did his colleagues on the witness panel challenge it. Why? Probably because Congress has finally begun a serious review of tax-exempt law, and it is willing to at least hear from those who think the current system needs a major overhaul. For the moment, at least, everything is on the table.

Continuing with the animal metaphor, the huge elephant in the tax-exempt room, according to Professor Colombo, is that many fee-for-service charities are indistinguishable from for-profit businesses. Why should a hospital, for example, get a tax exemption for providing a service that its patients pay for? The exemption, in effect, gives the charity hospital an unfair advantage over the for-profit hospital with which it competes for patients. He says the IRS should focus on whether the activity deserves a tax break—not the type of organization engaged in the activity. If the non-profit hospital charges for all of its services, it isn’t doing anything charitable.

His position is based on the sensible view that if the market provides a product or service, that is commercial activity that does not deserve a tax benefit. If the so-called charitable hospital is behaving exactly like its for-profit competitor, it should pay tax on its earnings. If it is a “real” charity, it will have no real net earnings because all the extra money will have gone back into health care rather than to shareholders, which means it would not pay taxes anyway. No harm to charity will be done. In the meantime, we will have taken a step toward a fairer tax system.

Thus, the focus is on the activity. The test would be whether the activity is genuinely charitable or commercial. How can you tell when something is charitable? Simple—it is charity when the market won’t do it. And the market does not provide free or below-cost health care. Colombo cited extensive existing precedents the IRS could rely on to determine whether an activity is commercial.

Colombo continued his focus on the commerciality of the charitable sector and his desire to promote “tax coherence” within it. He also proposed that all charities should be taxed on all revenue they might get from commercial activity, whether or not it is related to their missions. Thus, a soup kitchen would be taxed on sales of its canned soup. The result is fair treatment of commercial soup retailers, the IRS doesn’t have to decide how “related” such sales are to the charitable mission and the overall corporate tax base is protected. The implications for such a tax change would be enormous and would likely result in a significant shift of tax-exempt sector resources—for the better, Colombo argues.

Basically, Colombo’s thoughtful proposals aim to dismantle the tangle of law and regulation that has grown up around the mostly large and well-funded non-profit organizations that have used their assets in the commercial sphere to generate more revenue. He would separate all of it in the interest of genuine charity and economic efficiency.

My guess is that none of his proposals will come to pass despite their internal logic, simplicity and potential benefit. There are too many influential interests in the tax-exempt sector (as there are in all sectors of the economy) that prefer the status quo. But at least Congress is listening with an open mind, and so far it doesn’t smell anything fishy.

Bruce D. Collins is corporate vice president and general counsel of C-SPAN, based in Washington, D.C. Email him at collins@c-span.org.

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