The 2017 Tax Reform Act is best known for lowering individual and corporate tax rates, but it fills 500 pages of small print, and not all of it is good.
One negative side effect: It will make the hiring of senior executives much more expensive. Two sections pertain specifically to nonprofit organizations, including college endowments, charitable grant-makers, symphonies, museums, hospitals, and many other charitable entities.
The first imposes a 1.4 percent excise tax on the net investment income of certain private colleges and universities. We had our say about this elsewhere. This “Yale Tax,” as it might be called, will raise a risible $1.8 billion over 10 years. That’s only $180 million annually in a $3.8 trillion U.S. budget. It does little to fill any budget hole, instead serving as an empty political gesture for those justifiably aggrieved about college costs.
The second section will raise the cost of hiring senior employees at nonprofit groups generally. Section 4960 imposes an excise tax on “excess” executive compensation at tax-exempt organizations. Congress has decreed that any nonprofit employee compensation exceeding $1 million is “excess.”
The tax will amount to 21 percent of the so-called “excess” compensation, and it will apply only to the five highest-paid employees at any given non-profit. Chief investment officers — and CEOs and football coaches — will be relieved to know that the tax will be levied on the employers, not on the employees. But it will obviously have a knock-on effect on how much nonprofit organizations can afford to pay new hires, or how big a raise they can offer talented incumbents to help keep them aboard.
Some wag has referred to this as the Nick Saban Tax, in honor of the redoubtable Alabama football coach. Coach Saban is said to be the highest paid college coach in the country at $8.3 million in 2018.
Saban is well known, but there are more obscure execs also in the crosshairs, such as Anthony Tersigni, CEO of the huge Ascension Health system in St. Louis. He takes home $17.5 million. A few other nonprofit healthcare executives were also up in the 8-digit range. The Act explicitly excludes practicing physicians, who are often the highest paid people in these organizations. That means Ascension will be on the hook for at least $3.5 million annually just to keep Tersigni.
We estimate that the celebrated Yale chief investment officer David Swensen is currently making about $6 million. And we think the average CIO among big endowments now makes about $2 million.
The three named above are among the very best in their respective professions. They are arguably worth every penny of their admittedly handsome salaries.
In Saban’s case, the University of Alabama will have to budget for at least an additional $1.5 million yearly. And the Wall Street Journal has counted 2,700 nonprofit employees, not just at colleges, who were paid over $1 million in 2014.
Total take to the feds from the Saban tax might be $9.2 billion over 10 years, per the Joint Tax Committee. That’s more than the Yale tax, but the two together, at $11 billion ($1.1 billion per year) is still trivial in the context of federal budgeting.
Salary negotiation in the free market is, as the Nobel-winning economist F. A. Hayek taught, a discovery process. No one knows what someone’s work is worth until the market figures it out.
In our view, the boards and donors of charities are capable of deciding what portion of a nonprofit organization’s budget should be used to hire the best executive talent they can afford. We see no reason why government officials, who know nothing about managing those organizations, should load the budgetary dice. And if donors take exception to how a charity is run, they’re in the best way to influence policy is to withhold support.
Nonprofit groups don’t have taxable profits, so it doesn’t help them to limit deductions for salary expenses, as private businesses can. Hence this excise tax, which tries to impose the same degree of discouragement on an allegedly too generous tax-exempt employer using a slightly different mechanism. The new tax causes a historically tax-exempt charity is suddenly no longer tax-exempt.
As noted above, the revenue from these taxes will be minimal. So, what’s the point of quietly inserting them into a giant tax bill with minimal discussion or publicity? Unfortunately, it puts a federal foot in the door. A precedent is now being set for government to decide that endowments that are “too big,” or nonprofit executives are paid “too much.” It will motivate targeted organizations to come hat-in-hand to Congress, hoping to cushion future blows.
No doubt this is gratifying to Congress, but it just further distracts and impedes nonprofit leaders from accomplishing their organizations’ missions.
Charles Skorina is managing partner for Charles A. Skorina & Co. in Tucson, Ariz., where John Legere is a research partner.
