Analysis of Tax Reform 2.0 from a Social Enterprise Perspective
August 2nd 2018
On July 24, 2018, the House Ways and Means Committee released its framework for legislation relating to the Tax Cuts and Jobs Act of 2017. Dubbed “Tax Reform 2.0” the House plan would build on TCJA by accomplishing four main objectives:
Make the individual and small business tax cuts permanent.
Promote retirement savings.
Encourage saving by creating Universal Savings Accounts, expanding 529 education savings plans, and allowing families to access retirement funds to pay for the costs of caring for new babies.
Expand business write-offs for startup businesses and remove barriers to the growth of start-ups.
The committee’s framework is long on vision but provides no details on how these objectives will be accomplished. If legislation promulgating these objectives passes, it could affect social enterprise, which is the use of commercial and business strategies to address social problems (using nonprofit or for-profit legal entities or a combination of both). The effects may come in several ways.
The TCJA tax cuts for individuals had the effect of making charitable contributions more expensive for donors in the short term because the deduction, a form of subsidy, is smaller. For example, a donation of $100 will now cost the donor $80 (the non-deductible portion) instead of $60, a 50% decrease in the value of the deduction. Making these tax cuts permanent can be expected to negatively impact charitable giving on a long-term basis. Coupled with cuts in government support for social and environmental programs, this will reduce the income available to nonprofits that are working on pressing social and environmental needs. However, the needs themselves have not gone away; in most cases, they have increased. As a result, non-profit groups will need additional sources of revenue just to keep up with demand, and the most obvious way for them to get new revenue is by engaging in commercial activities, cause marketing, joint ventures, licensing, and other ways that allow them to monetize their programs, expertise and value to society. Since all of these activities can be considered “social enterprise” (some definitely are), the obvious result will be to increase the sector’s reliance on social enterprise as a tool for revenue generation, and to increase society’s reliance on social enterprise as a method of addressing social and environmental problems.
In addition, because nonprofits will have fewer resources available to them, the role of for-profit social enterprises relative to non-profit ventures can be expected to grow, since both the opportunity and need for these ventures will increase, but the ability of non-profit ventures to fill the gap will be impaired. This shift in roles will have the effect of moving more social and environmental activity out of the non-profit sector and into the for-profit sector over time. It may also lead to more innovation in non-profit cooperation with for-profit companies, and new opportunities for nonprofits to leverage their programs and expertise in the commercial or for-profit world. We can expect this to increase, for example, in areas such as health care, education, tourism, real estate development, workplace health and safety, alternative energy production and distribution, and other areas where positive social and environmental impacts translate into commercial opportunity.
The expansion of startup expenses also holds great promise for for-profit social enterprises. Although some for-profit social enterprises are large (some are even publicly traded), the majority of these ventures are relatively young and small, and can be expected to benefit from tax law changes that allow them to write off more of their startup expenses more quickly. However, until we understand what kinds of expenses are covered, how they are affected, and who specifically can benefit, it is difficult to say how these changes might affect the sector specifically.
One other side effect of this change may be to give for-profit social ventures a relative advantage in the marketplace compared to non-profit social ventures. This outcome is because non-profit ventures can take tax-deductible contributions, but they cannot issue shares and their ability to pay a return on capital is limited, making it difficult for them to raise working or growth capital. For-profit ventures, on the other hand, cannot accept tax-deductible contributions, but they can issue shares and can pay unlimited returns to investors. Their structure gives them access to equity capital to finance start-up, expansion, and other things that growing companies need, whereas non-profit ventures will not have access to these resources. This policy, in turn, may lead to an increase in nonprofits creating for-profit subsidiaries and joint ventures to finance their commercial and revenue-generating activities, using invested capital rather than donated capital (philanthropy.) It will also encourage greater innovation in how non-profit, for-profit collaborative ventures are carried out. As above, the devil will be in the details, which are not yet available.
Removing barriers to the growth of start-ups will have much the same effect as permitting greater write-offs of start-up expenses – it may result in stronger and faster growing social enterprises. Access to capital is just one area where barriers could be removed. Allowing both for-profit and non-profits easier access to capital, allowing nonprofits to pay a return to investors through new, highly subordinated forms of debt, and similar changes would benefit all social enterprises. Other changes that might have an effect include giving non-profit social enterprises greater freedom to collaborate and cooperate with for-profit entities (for example by expanding the permissible scope of such arrangements and loosening restrictions on certain kinds of compensation.) Some changes, such as allowing nonprofits access to SBA loans, would help non-profit social enterprises by giving them a level playing field compared to for-profit ventures.
Practitioners are eagerly awaiting more detail on the Committee’s proposals. The Committee has said that they hope to introduce a bill may in the next few weeks, with the goal of having something passed — at least by the House — in September or October 2018. That may be optimistic, and the Senate has yet to weigh in on these proposals, so we will continue to watch developments in this area with interest.