Tax Cuts and Government Shutdowns Force Difficult Choices

Two nonprofit clients come in to request social services. Joe is in need of help but is less needy than Jeff. Helping Joe will take less time and resources. This will make it easier to move on to other clients who need help. Jeff will take up your entire afternoon because he has so many needs, which will leave you without being able to meet your quota to meet your government contract’s requirements.  Who do you choose to serve?

It may seem as if the tax reform efforts that were just passed by Congress and signed into law by President Trump and the government shutdown are seemingly unrelated to the work most nonprofits engage in. However, they will force more organizations to make difficult choices regarding whom they can serve. The fact is that the macro impact of the tax cuts is compounded by other worrisome economic trends (e.g., growing debt ceiling, government shutdowns, etc.) that will have significant implications for nonprofits and their operations.

Although there are differing opinions on the benefits of the tax cuts on the economy, there is general consensus that this tax bill translates into a reduction of income for the United States government and an increase in our national deficit. This will ultimately translate into less money for the federal government, states, and municipalities. It could also spur reductions in benefits for Social Security, Medicare, and Medicaid if new forms of revenue are not identified to cover our national debt.  The only way nonprofits can prevent or minimize the potentially catastrophic long-term impact of the tax cuts and government shutdowns on the nonprofit industry is through advocacy efforts that extend beyond raising awareness.

I am going to cover some rather technical topics, but they are worth taking the time to understand because they will have an impact on nonprofits. We are going to discuss:

• Why the 2017 tax cuts happened, and what it was hoping to accomplish, but most likely won’t;

• Why nonprofits should care about the impact of the tax cuts, tax policy, national debt, government shutdowns, and fiscal policy;

• The impact of decreased government revenue on programs funded by taxes;

• The consequences for government and nonprofit organizations;

• What nonprofits can do about it; and

• How nonprofits can prepare their organizations for the worst scenario.

Unlikely the Tax Cuts Will Increase Tax Revenues Long-Term

I think it’s important to begin by describing what the tax cuts are hoping to achieve.  Many of the principal architects of the bill, as well as its supporters, believe that these tax cuts will stimulate job growth and strengthen our economy.  Their rationale is grounded in a theory that economist Arthur Laffer developed in 1974 called the Laffer curve. It is worth noting that most economists do not agree with Laffer’s belief that deep tax cuts will stimulate significant economic activity that will, in turn, increase tax revenues. In fact, many economists believe that tax cuts are often a less effective means of stimulus than spending increases, particularly when they target the wealthy. There are numerous economic models and theories that suggest that tax cuts for the wealthy will not result in economic growth because when people with means have more disposable income they tend to save their money instead of spending it. Whereas individuals with more modest incomes will be more likely to spend the money than to save it.

This brief synopsis of tax policy theory is, of course, an extreme oversimplification that does not begin to outline all of the scenarios or multipliers that institutions like the Congressional Budget Office and economists take into consideration when determining whether tax cuts or fiscal policy will spur economic growth or decline.  Irrespective of which scenario materializes, the potential stimulus from tax cuts or spending always depends on the strength of the economy.

So, Let’s Look at the Strength of Our Economy…

Due to the growth and size of our economy, we have been able to overcome many obstacles that for many other countries would discourage investment. Nonetheless, there are certain warning signs that we must all tune into so as to prevent negative economic outcomes when considering tax cuts. The first worrisome fact to consider is that the United States has an incredibly large debt ratio.  Although countries like Portugal and Japan have larger debt loads in comparison to our economy, the United States is currently facing a $14.4 trillion deficit, which is about 77 percent of the nation’s gross domestic product (GDP). This debt is issued in US bonds that are held mostly by the public and foreign investors. The Congressional Budget Office estimates that this deficit will significantly increase over the next two decades due to the growing demand from Baby Boomers for Social Security and Medicare benefits.

The question then, becomes, how much debt is too much before economic growth is impacted and investors are discouraged from investing in the United States? There are different ranges that economists see as an acceptable level of debt, with some arguing that even up to a level of 100 percent is acceptable. The proportionality of the debt to the economy really becomes problematic, though, when investors worry that the federal government will no longer be able to pay both the interest and principal on its bonds. If this scenario occurs, investors may refuse to lend the government additional money at normal interest rates.

Currently, investors have confidence in our economy, but certain factors could raise concerns for them, including:

• The ongoing pattern of raising the debt ceiling without making fiscal and tax policy adjustments that will result in a stronger economy;

• The government shutdowns that stop it from paying its bills, including delayed payments to nonprofits, which reduces access to services;

• Increased demand for services and programs with mandatory payments, but insufficient funding to cover all of the costs; and

• Less revenue from the recent tax cuts.

It is worth noting that many of the economic models that measure the national debt underestimate how much debt really exists because they do not look at intragovernmental debt, which is when the government borrows money from itself. Some examples include when the government borrows from the Social Security Fund, the Transportation Fund, or the Pension Fund for government employees.

Yawn! Why Should You Care About This Tax and Fiscal Policy Snooze Fest?

Without tax and fiscal policies that curb the national debt, stimulate investment, and increase revenue, the government will be forced to use larger portions of the federal budget to pay for the growing publicly held, and hidden debt. As a result, simple math will force policy brokers to make difficult decisions to cover the debt. Spending on mandatory and entitlement programs such as Medicare and Social Security will take precedence over discretionary programs that fund education, human services, CHIP, the arts, infrastructure, etc. If the worst-case scenario were to materialize because of the tax cuts, depleted government coffers could even trigger a reduction of benefits for Medicare and Social Security as more Baby Boomers become recipients. This will translate into a lower standard of living for the most vulnerable, but also for people who do not realize that they are currently at risk.

Tax Policy Impacts Public, Private, and Nonprofit Stakeholder Behavior for Programs that Depend on Tax Credits or Revenue 

Inevitably, tax reform focused on tax cuts that create a sense of uncertainty regarding the stability of the revenue source will compromise programs that rely on private, public, and nonprofit partnerships. One such industry is the affordable housing market, which depends on subsidies that are funded by the low-income tax credit program. Developers can receive up to 70 percent of the funding from this program to cover the costs of new housing projects. Banks then buy the tax credits, thereby, making equity investments in the projects that will allow them to claim a range of tax benefits over a 10-year period. As banks begin to assess whether it makes sense for them to make investments in affordable housing projects, delays in decision-making can then translate into delayed projects and increased denials.

Social Safety Net in Danger: Nonprofits and Government Were Already Underfunded Before the Tax Cuts

With respect to discretionary spending, reductions in tax revenue will significantly hamper government agencies in carrying out their mandates. As it stands, many government agencies are short-staffed and under-resourced. Even when the economy is growing, the policy process poses obstacles to managing the implementation of legal, legislative, and regulatory mandates.  Short-term policy planning prevails since departmental priorities change with the promulgation of each new annual budget and throughout the fiscal year. Furthermore, departments are increasingly responsible for administering more legal and legislative mandates with diminishing resources and staff. This results in uneven programmatic applications and ultimately compromises the long-term sustainability of legislative directives. Similarly, nonprofits that receive public funding to implement the legislative and legal mandates that federal, state, and local governments must implement, experience similar challenges.

New Public Management (NPM) has emerged as the primary approach to managing government. This management philosophy emphasizes fiscal efficiency above all, and it has heavily influenced nonprofit contracts and grants with little regard to the impact on the nonprofit business model. Furthermore, government administrators faced with severe staff and monetary shortages have shifted their costs to their partnering nonprofits. Thus, in keeping with NPM, the organizations are then expected to increase their efficiencies with less funding and resources.

Many in government, and in the general public, believe that the funding reductions can be made-up by fundraising efforts. However, most private and philanthropic donors are often not interested in funding direct services. There are also limited philanthropic funding sources, and most funders are not interested in funding the operational costs of human services either.

While nonprofits are absorbing the costs of government, they are also experiencing increasing oversight for growing mandates with less or stagnant funding. These mandates are also accompanied by burdensome reporting requirements that do not accurately reflect the effectiveness of grant and contract-funded programs. Subsequently, nonprofits are facing higher costs with stagnant or decreasing funding. This situation has brought about a phenomenon known as the “Starvation Cycle”.

Reduced revenues from tax cuts or increased debt will place further limitations on government agencies which will be forced to make significant cuts in programs and transfer more costs to nonprofits. This will force many nonprofits to shut down, choose between quality and services, and/or eliminate vital services that are currently serving as a buffer against larger-scale poverty.

Advocacy Is the Only Answer, but It’s Complicated… 

Engaging in advocacy on behalf of nonprofits with respect to tax cuts and decreased tax revenues, the national debt, and preventing government shutdowns can be daunting. However, you do not need to understand complex mathematical formulas or econometrics to understand the following:

• Less income from tax cuts and growing national debt will translate into budget cutbacks and reduced services. Increasing the debt ceiling without implementing fiscal and tax policies that increase revenue to reduce our proportion of debt in relation to our budget, will result in a short-term reduction in services because the mandatory debt repayment will trump discretionary spending on programs that fund the work of nonprofits.

• Shutting down the government is an irresponsible fiscal management approach that diminishes confidence in the stability of our economy and delays services. It is important to implement tax and fiscal policies that continue to adequately fund nonprofits, which make up the silent infrastructure that protects communities from poverty and poor social outcomes. Nonprofits serve as pillars of community sustainability, and they are the primary providers of human, health, and services.

• Remind policy brokers at all levels that nonprofits serve as buffers against poverty. Decisions should be driven based on human needs with a focus on improved outcomes, and not based on politics during changes in the executive.

• Demand common-sense approaches to policy-making, particularly fiscal and tax policy. Join up with your state nonprofit association to oppose efforts for budgetary cuts that reduce funding for nonprofits, and grow our national debt.

Prepare Your Organization

There is a saying in Spanish that states, “Fear is the worst advisor”. In keeping with this sentiment, prepare your organization now for the potential challenges it may be facing in the near future due to the tax cuts. Although it is impossible to know with full certainty how the economic situation will play out from the tax cuts, and how deeply organizations will be affected, nonprofit leaders should begin to consider solutions now. They should come together to engage in scenario planning and outline the steps that need to be taken in the event of a dramatic reduction in government and private funding from the tax cuts.

Examine your organization’s environmental capacity by thinking about whether in a time of funding scarcity, your organization will continue to be viable. Assess the likelihood your organization will continue to be supported by the social, economic, and political conditions. If you are unlikely to survive because of your size or an incompatibility with the policy priorities of the government, consider strategies for an organizational redesign (e.g., program transfers, mergers, subsidiaries, etc.).

It is also important to assess where the organization can increase efficiencies, otherwise, its survival becomes questionable. Prioritizing what is most important to the organization will help the organizational leaders make difficult decisions about resources, programs, and staff. Options you will have to consider will include:

• Curtailing or eliminating programs vs. expanding on the organization’s niches,

• Eliminating optional services,

• Reductions in staff,

• Furloughs,

• Incorporating or increasing fees for service,

• Reducing employee benefits,

• Revamping your fundraising priorities, and

• Incorporating technology to lower transaction costs.

This, of course, should be done in conjunction with an intense development plan that takes into consideration the increased competition from other nonprofits, and the reduced incentives for tax deductions from private donors to make philanthropic gifts. For more information on the overall impact of the tax cuts on nonprofits click here.

Conclusion

More than ever, it is important to keep your pulse on the policy decisions of our lawmakers. No longer is it enough to pay attention to best practices, trends in your field, or quality of services. Nonprofits are going to have to come together to make a case for preserving the services that nonprofits provide at various levels as governments see reduced revenues from tax cuts. Nonprofits are already unnecessarily strained by funding models that create no-win situations and inhibit the quality of care. Further reductions in funding will create unbearable ethical dilemmas, such as choosing to serve the neediest, Jeff, versus the easiest to serve, Joe.

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