Politics, Not Policy

May 22, 2012

WASHINGTON -- Municipalities need money. Nonprofit institutions have money. Municipalities go after that money.

That’s how David L. Thompson, vice president for public policy for the National Council of Nonprofits, described the current set of debates about payments in lieu of taxes (PILOT), agreements that property-tax-exempt nonprofits -- often under duress from local officials -- strike with local governments to help municipalities balance their budgets. Thompson, whose organization opposes PILOT agreements, was condemning the practices that local governments have used recently to extract agreements from nonprofit organizations.

Thompson was speaking as part of a daylong series of panels hosted Monday by the Urban Institute, a nonpartisan think tank here, to discuss the current political and policy debates surrounding tax-exempt institutions and PILOT agreements. PILOT agreements have been in the news in recent years as municipalities, struggling with budget imbalances resulting from the economic downturn and increased pension and health care obligations, have attempted to renegotiate agreements or strike new ones. The push has led to contentious fights in several cities, including Pittsburgh and Providence, R.I.

Over the course of the day, speakers said they believe municipalities, and potentially regional governments such as counties, will place increasing pressure on nonprofits to contribute more to local government budgets. Most of the speakers were supportive of PILOT agreements, recognizing that the size and role of nonprofits, particularly large colleges, universities and medical centers, have changed dramatically since states established the tax exemption. Such organizations also use up a significant amount of municipal resources, they argue. Colleges and universities, particularly those that own a significant amount of land and have considerable financial resources, are likely to be an easy target for government pressure.

And unless state governments or Congress can determine a broad policy that helps municipalities address structural tax problems, PILOT fights will continue to be determined by local politics, which could result in less-than-optimal policy. “What we’ve been dealing with so far has been politics,” Thompson said. “We have not heard any policy.”

The policies that dominate the debate are state constitutions and statues that exempt charities from taxes. Seventeen state constitutions mandate charitable exemptions for nonprofit organizations, according to a study conducted by Evelyn Brody, a tax law professor at the Illinois Institute of Technology's Chicago-Kent College of Law. In 25 other states, constitutions grant state legislatures the authority to give charitable exemptions.

In both cases, there is some debate as to what is actually considered a “charitable organization.” Most states have requirements that go beyond an institution qualifying for 501(c)(3) status from the Internal Revenue Service. Three states -- California, Illinois and Pennsylvania -- are currently debating the requirements for being considered a tax-exempt institution, including how many state or city residents an organization directly benefits. National universities, whose educational and research missions often have a national focus, rather than a local one, are particularly vulnerable under that consideration. In Pennsylvania, the issue of how far the state legislature can go in interpreting the constitutional exemption has also become part of the debate.

But because state policies in general grant the exemption broadly, colleges facing PILOT pressure have a strong negotiating position. “When you have a PILOT negotiation going on, you have a statute to fall back on,” Brody said. "The default position is exempt."

That has not stopped municipalities -- particularly those in the Northeast that predominantly rely on property taxes for their revenues -- from trying to get nonprofits to commit to PILOT agreements, with wealthy universities and medical institutions as the primary targets.

In recent years mayors and city councilmen have tried to argue that colleges aren’t paying their “fair share.” They tend to point to how much of the municipal land is not taxed, an argument that has frustrated nonprofits, since such tabulations have tended to include city, state and federal government property. In many municipalities, where manufacturing has declined, colleges and universities have bought up land, resulting in a dramatically different property tax base.

Only a handful of states have adapted their policies to deal with the changing size and role of nonprofit institutions and the potential burden they pose to municipalities. Connecticut reimburses municipalities that house large, property-owning nonprofits, dispersing the burden.

But in general, politics and short-term budget problems have tended to determine which municipalities seek PILOT agreements and how much each institution has agreed to pay. An agreement in Pittsburgh was partly motivated by the mayor’s proposal to impose a tax on tuition at the city’s colleges and universities. In Providence, the city council threatened to revoke Brown University’s tax-exempt status.

Daphne Kenyon, an economist at the Lincoln Institute of Land Policy, said there is growing support for taxing traditionally tax-exempt institutions, particularly colleges, hospitals and even religious institutions. Speakers at the Urban Institute meeting said it might be financially better for nonprofits to strike PILOT agreements now to mollify critics rather than face the revocation of their tax-exempt status in a few years.

Boston struck one of the most prominent PILOT agreements in recent years when it convened a group of nonprofit leaders and government officials to hammer out a five-year voluntary agreement in which institutions with an assessed property value above a certain threshold would pay 25 percent of what they would pay if they were taxed. A unique facet of Boston's agreement was that institutions were allowed to deduct up to 50 percent of their expected contribution if they could demonstrate activities that directly benefited the community.

Ronald W. Rakow, the city’s commissioner of assessing, said institutions are much more amenable to providing services for a city than directly paying cash. For universities, this could include programs such as scholarships for city residents or consulting with local school districts.

On one hand, such a setup helps keep a formal tax-like agreement off the books. It also allows the nonprofit institutions to perform services related to their mission instead of potentially supporting programs they do not necessarily support (or having that money wasted by an inefficient local government).

But that preference is somewhat unfortunate for cities, Rakow said, since “cities have a strong preference for cash over services.” But he noted that nonprofits may be significantly more likely to contribute to community needs if the contribution were to come in some form other than a check.

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