Tax Day -- April 15th -- is upon us. As Americans race to file their income tax returns, the IRS will likely record about $220 billion in charitable donations made by individual taxpayers, with tax savings resulting from those donations equaling around $45 billion. The idea is that by subsidizing charitable donations, we as a society are getting greater positive social impact than we otherwise would. It's logical to ask, "How can we get the most positive social impact for our money?"
Congress will soon consider tax reform, and some people are arguing to eliminate the deduction for charitable contributions. But given the enormity of the country's most pressing social problems, rather than eliminating or even curtailing the charitable deduction, it's time to figure out how to make individuals' charitable dollars go even further.
Charitable foundations can use their grant dollars to make Program Related Investment (PRI), in nonprofit or for-profit organizations that further the foundation's social impact mission. PRIs return the grant capital and sometimes an additional financial return to the foundation so they can "recycle" the capital and thus use it repeatedly for social impact. It's time to think about we can adapt these tools to individual giving.
Currently, there are no avenues for individuals to "recycle" their social impact dollars for repeated good. But there could be. In 2010, approximately $40 billion were held in vehicles known as Donor Advised Funds (DAF); historic growth rates suggest that these assets have grown close to $45 billion, even as grants to charities of over $7 billion are being made each year. DAFs are an investment vehicle through which individuals make charitable donations. Individuals take the charitable deduction on their taxes in the year they make the donation to the DAF; an actual donation to a charity can be made in a later year. DAFs are generally managed by financial institutions or community organizations. These DAF "sponsors" manage the assets that are placed in DAFs and help donors vet and choose charities to support. Technically, in a DAF, the donor can only advise the DAF sponsor as to where to make charitable donations. But, in effect, sponsors follow donors' "advice" as long as the recipient qualifies as a charity.
Currently, with very few exceptions, DAFs must be used for traditional charitable grants; these funds cannot be used for an investment that yields any financial returns to the DAF, so there is no "recycling" these dollars for good. Many nonprofits have earned income streams that could benefit from equity investment and/or debt. Further, initial findings from the Great Social Enterprise Census suggest that around half of all social enterprises in the US -- especially ones formed since 2005 -- are for-profit enterprises striving to at least breakeven financially while also making a positive social difference. We know that these social enterprises, like so many small businesses, are starved for capital. They cannot attract private equity or debt because their earnings are insufficient to yield reasonable returns and/or cover the debt service and they do not qualify as charitable entities and thus cannot reap donations.
As the number of for-profit social enterprises is growing, so is the effort to measure their impact and create standards to identify the best among them. The Global Impact Investing Ratings System (GIIRS) and the Impact Reporting Investment Standards (IRIS) have created a minimum standard and a consistent set of definitions, respectively, to better enable an "apples to apples" comparison of enterprises' social impact. While the numbers are still relatively small, nearly 1000 companies that have a primary, intentional social mission have certified as "for benefit" or B Corporations. Efforts like these are in the early stages, but are essential; if we are to create policies to support social enterprises, then we have to have a clear understanding and definition of what is a social enterprise.
With greater clarity, standards and definitions, it would be relatively simple to allow DAFs to invest in social enterprises. We would need to define a social enterprise eligible for a DAF investment. For example, we might establish a few different ways that a social enterprise could qualify. Perhaps we create a federal certification system akin to the CDFI designation but allows broader social purpose. An alternative way for a social enterprise to qualify might be if it scored above a certain threshold on the B Corporation test. There are other possible definitions; suffice it to say that policymakers will need to agree on a definition, but once we have that definition, we need only ensure that any financial returns to the DAFs remain in the DAFs, do not accrue to the benefit of the original donor and are granted to charities or re-invested in social enterprises. DAF sponsoring organizations would determine that a specific organization complied with the established definition before releasing the investment from the DAF and would process and manage the assets that were returned, just as they manage assets when they are first placed in the DAF.
Relative to overall charitable giving, DAFs are small. This vehicle is used by high net worth individuals, those who are more sophisticated investors and qualify as "accredited investors." This audience knows what it's doing, and is increasingly interested in innovative approaches to addressing social problems. Allowing DAFs to make investments akin to foundation PRIs is a logical next step to ensure that the American people are getting the most bang for their buck when it comes to the charitable donation tax deduction.