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Book Review: Unfair Competition: The Profits of Nonprofits by James T. Bennett and Thomas J. DiLorenzo

SEPTEMBER 01, 1989 by PETER FRUMKIN

Hamilton Press, 4720 Boston Way, Lanham, MD 20706 • 1989 * 214 pages • $17.95 cloth

A t first blush, the operation of a museum gift shop seems harmless enough. Who could care if a worthy institution like the Richmond Museum makes a little cash on the side by selling postcards and other small items? Probably no one. But what about a nonprofit YMCA that serves young professionals at a lower cost than a local private health club, driving the club out of business? In this case, the issues become less clear and the questions more complex. Are some nonprofits using their nonprofit status to compete unfairly with their for- profit counterparts? Do nonprofit organizations enjoy subsidies that make true competition impossible? How can the need of nonprofits to raise funds be balanced with the concern of the business community that an unfair advantage exists which distorts the market? These are just some of the questions that James T. Bennett and Thomas J. DiLorenzo raise in their stimulating new study of the nonprofit economy, Unfair Competition.

Tax-exempt organizations are one of the fastest growing segments of the economy. In 1987, annual revenues exceeded $300 billion—or about 8 percent of the gross national product. They have, however, only begun to attract significant attention from researchers.

The very fact that many nonprofits are actively engaged in for-profit commercial activities may come as a surprise to some. After all, thoughts of the nonprofit community hardly conjure up images of profitable operations generating significant revenues. In reality, however, many nonprofits are growing increasingly dependent on the funds which their various business ventures generate.

Is this a development that should be greeted with enthusiasm as a harbinger of lower costs to consumers? If the analysis contained in Unfair Competition is correct, there may well be hidden costs—and stiff ones at that—which need to be weighed before we accept the continued profiteering by the nonprofits. Bennett and DiLorenzo argue in fact that the phenomenal growth of the nonprofit sector has been achieved on the back of private business, with small for-profit firms suffering the most from the unfair competition of tax-exempt commercial organizations.

Nonprofits enjoy a whole host of advantages-chief among them being tax-free status and reduced postal rates- -that give them an unfair advantage in the marketplace: “The effect of these special privileges is that governmental policy not only reduces the costs of nonprofit organizations, but it also raises the costs of doing business for their for-profit competitors. Profit-seeking firms must pay higher taxes and postal rates to offset the subsidies accorded non-profits. Thus, because of this preferential treatment, competition between nonprofits and for-profits is inherently unfair.”

Attempts by government to address the problem of unfair competition have been few and far between, and those few measures that have been taken have been largely ineffective. The Unrelated Business Income (UBI) Tax which was intended to level the playing field by taxing the revenues of nonprofits has, for example, proven difficult if not impossible to enforce. Bennett and DiLorenzo explain that the courts have not been able to give a rigorous and consistent definition of just what constitutes an “unrelated” business activity by a nonprofit. And because the UBI tax was to apply only to “commercial activity which is not significantly related to the purposes for which the nonprofit organization was established,” enforcement and collection by the IRS has been less than successful. For their part, nonprofits have taken an extremely expansive view of what constitutes a related purpose, making the under-reporting or non-reporting of revenues commonplace.

Even if nonprofits enjoy an unfair advantage over private businesses due to tax breaks and postage subsidies, why should anyone worry? Bennett and DiLorenzo’s answer is simple: unfair competition impedes the development of small business by making it hard for them to enter markets and compete. This is significant because two-thirds of all new jobs are created by businesses with fewer than 20 employees. The authors note that because commercial enterprises run by non-profits are exempted from taxes and receive’ other subsidies, taxpaying businesses must bear an extra burden by paying higher taxes than they would otherwise to make up for exemptions enjoyed by their “nonprofit” competitors, Bennett and DiLorenzo conclude that unfair competition ends up crowding out of the market ,precisely those firms which are the principal source of new jobs—ultimately reducing the rate of economic growth.

The solution to unfair competition that Bennett and DiLorenzo offer is clear: “Nonprofits entering a commercial undertaking must form a for-profit subsidiary that must obey all the same laws and regulations that apply to for-profit enterprises.” For according to the authors it is only when we move beyond hidden subsidies and the ineffectual regulations of UBI taxes that both consumers and producers will be able to enjoy the benefits of even-handed competition.

Unfair Competition makes a powerful case that the time to crack down on the profiteering of nonprofits is upon us and the future of free markets and fair competition rests in the balance. Some may differ with the recommendations of the book and favor less radical and sweeping reforms. One may hope a solution can be found which will both allow nonprofits to continue to operate on a fee for service basis and which will also ensure that the interests of private for-profit businesses are not damaged in the process. Any such compromise must, however, start from the premise that free enterprise and a level playing field are non-negotiable items.

Peter Frumkin is a graduate student at Georgetown University where he is studying public policy.

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September 1989

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