The Undermining of American Charity
Lewis Cullman and Ray Madoff write in the NY Review of Books:
Our backgrounds may be relevant to the criticisms we make here of a major flaw in the financing of charities today. Lewis Cullman is a New York philanthropist who, at the age of ninety-seven, has given away over 90 percent of his wealth to charitable causes. Ray Madoff is a professor of law at Boston College and the director of a think tank on philanthropy at Boston College Law School who has written—as has Lewis Cullman—about the ways by which the tax system grants benefits to donors to private foundations without ensuring that those donations are put to charitable use.1
We now write because we are alarmed about a major new force that has entered the field of charitable giving. It has so far been hardly noticed by the general public. But now it is threatening to undermine the American system for funding charity. This force is the commercial “donor-advised fund,” the fastest-growing, but still largely unknown, charitable vehicle.2 Donor-advised funds (or DAFs) give donors all of the tax benefits of charitable giving while imposing no obligation that the money be put to active charitable use.
The rise of DAFs is a matter of grave concern because of the heavy reliance on charitable contributions in the US. In other countries it is common for universities, hospitals, art museums, symphonies, and social safety nets to be funded by governments. In the US, charitable organizations, supported by tax-favored private donations, carry out many of the same social functions. The American system depends on an adequate flow of private donations to working charities, and anything that disrupts this flow can have critical consequences for charitable organizations and the people they serve.
Here we explore the reasons for the current explosion of DAFs and its implications.
Most Americans have never heard of donor-advised funds and would be surprised to learn that, measured in donated dollars, the second-most-popular “charity” in 2015 (just behind the United Way) was not the Red Cross, the Salvation Army, or Harvard or other universities. It was Fidelity Charitable, an organization created and serviced by Fidelity Investments for the purpose of holding charitable donations. Fidelity Charitable acts as a middleman, attracting its customers’ charitable donations and managing them in separate client accounts. Money in such donor-advised funds is invested and held until the clients give instructions (“advise”) about distributions to operating charities.
Because of a 1991 IRS ruling obtained by Fidelity (and similar rulings obtained by other commercially sponsored DAFs), clients get the same tax benefits when they transfer property to their donor-advised funds that they would get by making outright contributions to a museum, soup kitchen, university, or any other federally recognized charity. But no deadline is imposed for the eventual distribution of these funds to an operating charity. If a donor fails to distribute the account during her lifetime, she can pass on the privilege of making distributions to her children or grandchildren or anyone else she chooses. The effect of these rules is that assets that have been given the tax benefits of charitable donations can be held in a DAF for decades or even centuries, all the while earning management fees for the financial institutions managing the funds, and producing no social value.
Although Fidelity was the first financial institution to create this type of charitable middleman, Schwab and Vanguard soon thereafter created Schwab Charitable and Vanguard Charitable—and together these organizations have all made it to The Chronicle of Philanthropy’s annual top ten charities in overall donations (squeezing out more traditional charities like the American Cancer Society). Goldman Sachs, T. Rowe Price, Raymond James, and many others have also created donor-advised funds, making charitable giving a growing part of the financial world’s business model for attracting and servicing its clientele.
This business plan has been highly successful. . .