Thursday, December 28, 2006

No free lunch 

Arthur Brooks (subscribers' link) discusses the negative elasticity of private charity with respect to government largesse:

One large nonprofit organization that helps the poor in New York state illustrates this point. The agency was relatively small a few years ago, but provided a critical service in several cities. The state, taking notice of the organization's good work, began pouring money into operations, doubling and tripling its budget. The staff was focused on managing and spending the public dollars, and allocated less and less of its time to private fundraising -- which, predictably, vanished. When the state, facing budget cutbacks, began to reduce the organization's subsidy, it led to service cuts and layoffs because there were no private funds to fill the gap. Ironically, the organization and its clients were worse off than they would have been had the nonprofit received no government "help" in the first place.

This experience is hardly unique -- indeed, nonprofits and their communities all across America are exposed in the same way when government funding grows as a source of support. According to the National Center for Charitable Statistics, a quarter of human service charities in 2002 received at least 50% of their income from the government. This represents a lot of risk, because public funding is pro-cyclical: It increases or decreases more than changes in the economy, and thus can destabilize nonprofits. In contrast, charitable donations stabilize charities because they fluctuate less than the economy as a whole. For a charitable organization, relying on government funding as the main income source is like investing your 401(k) entirely in biotech stocks: You might do great -- for awhile.

But the problem with government money goes beyond just its volatility: Studies by economists over the past decade have demonstrated that government spending on nonprofit activities actually lowers private charitable giving. In the case of social welfare services, a dollar in government funding to nonprofits generally suppresses private giving by 25 cents or more. Part of this is due to a lower perception of need among charities when they get public money. There is also evidence, however, that charities spend less effort fundraising after governments give them money.

As Brooks and many other researchers in that area (including two of my colleagues, Patricia Hughes and Bill Luksetich), the crowding out of private charity is usually not dollar-for-dollar. (See for example, this short summary by Brooks a couple years ago.) Some areas it is higher, others lower -- and a few papers might even find crowding in for relatively small charities who were constrained from advertising and fundraising by a lack of funds. What Brooks points out here isn't just the volatility and the crowding out, but that government funds cause an increase in administrative expenses that reduce programmatic expenditures. That's a testable hypothesis.

One such paper by my colleagues finds that the impact of government funding on management expenditures is relatively small -- maybe a $.03 increase for each dollar of government funding provided for performing arts organizations. Where the money seems to go is into excess revenues. If the money from government to charities is pro-cyclical, and charities know it, wouldn't they rationally save that money for recession periods to smooth program expenditures? Both authors are away this week, so I'll have to ask them when they get back.