American Charity
By 
“Helping the Poor–Gratuitous Distribution of Coal by the City–Cherry Street,” New York City, 1877
Most Americans have never heard of donor-advised funds and would be surprised to learn that, measured in donated dollars, the second-most-popular “charity” in 2015 (just behind the United Way) was not the Red Cross, the Salvation Army, or Harvard or other universities. It was Fidelity Charitable, an organization created and serviced by Fidelity Investments for the purpose of holding charitable donations. Fidelity Charitable acts as a middleman, attracting its customers’ charitable donations and managing them in separate client accounts. Money in such donor-advised funds is invested and held until the clients give instructions (“advise”) about distributions to operating charities.
Because of a 1991 IRS ruling obtained by Fidelity (and similar rulings obtained by other commercially sponsored DAFs), clients get the same tax benefits when they transfer property to their donor-advised funds that they would get by making outright contributions to a museum, soup kitchen, university, or any other federally recognized charity. But no deadline is imposed for the eventual distribution of these funds to an operating charity. If a donor fails to distribute the account during her lifetime, she can pass on the privilege of making distributions to her children or grandchildren or anyone else she chooses. The effect of these rules is that assets that have been given the tax benefits of charitable donations can be held in a DAF for decades or even centuries, all the while earning management fees for the financial institutions managing the funds, and producing no social value.
Although Fidelity was the first financial institution to create this type of charitable middleman, Schwab and Vanguard soon thereafter created Schwab Charitable and Vanguard Charitable—and together these organizations have all made it to The Chronicle of Philanthropy’s annual top ten charities in overall donations (squeezing out more traditional charities like the American Cancer Society). Goldman Sachs, T. Rowe Price, Raymond James, and many others have also created donor-advised funds, making charitable giving a growing part of the financial world’s business model for attracting and servicing its clientele.
This business plan has been highly successful. Many billions of dollars have been drawn into the orbit of charitable middlemen, and there is no end to their growth in sight. According to the National Philanthropic Trust, annual contributions to DAFs hit an all-time high of $19.66 billion in 2014. The increase in contributions, combined with a rising stock market, “drove total donor-advised fund assets above $70 billion for the first time.”3 The leader, Fidelity Charitable, has had particularly strong growth and it is widely expected that in 2016 it will surpass the United Way and receive more donations than any other charity in the country.
So what’s the problem?
The main beneficiaries of the arrangements for commercial DAFs are the financial industry and its wealthy clientele. The financial industry profits from commercial DAFs in several ways.
First, financial institutions profit from commercial DAFs because they are a source of investment assets. Fidelity, Schwab, Vanguard, Goldman Sachs, and other financial institutions are in the business of managing money; the more money they manage, the more profits they make. By creating charitable entities that can hold charitable dollars for investment, the associated financial institutions create an additional revenue stream that adds to their bottom line.
Second, financial institutions are able to earn fees by providing management services to the charities set up specifically to hold the DAF funds. For example, the for-profit Fidelity Management provides all management services for Fidelity Charitable. This type of arrangement also conveniently enables commercial sponsors of DAFs to avoid federal disclosure rules that otherwise require charities to disclose the salaries of their top-paid employees.
Finally, commercial DAFs also provide financial benefits to individual financial advisers who can continue to receive fees for investing their clients’ charitable donations. When a client discusses charitable giving with his financial adviser, the adviser has every financial incentive to recommend that the client establish a DAF rather than make an outright gift to an operating charity. One effect of these arrangements is to add a good many members to the DAF sales force.
The financial industry has clearly had much to gain from entering into the DAF middleman business. The question is, why would donors contribute billions of dollars to DAF middlemen, preserving only the right to make nonbinding recommendations about the distribution of the funds? The answer is that DAFs help donors get maximum tax advantages for their charitable contributions. There are three main reasons for this.
First, commercial DAFs make it easy for donors to time their charitable donations in a way that produces the most tax benefits. The value of the charitable deduction is directly linked to the tax bracket of the donor. For someone taxed in the highest bracket (39.6 percent), a $100 donation produces almost $40 in tax savings. For someone taxed at a 15 percent bracket, the value of the tax deduction is only $15. And for the vast majority of Americans who don’t itemize their deductions, the charitable deduction provides no benefit at all. DAFs allow donors to maximize tax savings by making large charitable contributions to DAFs in years when they owe high taxes (maximizing the tax benefit), and then using the funds to make distributions to charities in later years.
Second, commercial DAFs make it easy for donors to make contributions of property—including shares of stock—rather than cash. These donations can save an additional 20 percent in the capital gains taxes the donor would otherwise pay. Thus, while a gift of $100 cash by a high-income taxpayer can save that taxpayer nearly $40, a gift of $100 of property can save the taxpayer close to $60 in combined income and capital gains taxes.
Finally, DAFs make it easy for donors to save on taxes by getting the maximum tax benefit for contributions of “complex assets.” For financial institutions the words “complex assets” refer to property that is not publicly traded stock. Complex assets can include such varied holdings as commercial and residential real estate, art, private business interests, and even mineral rights, yachts, and taxidermy collections. A significant part of the work of commercial DAF sponsors consists of acting as a tax-free clearinghouse for complex assets.
The ability to get this enhanced charitable deduction for donations of complex assets is particularly valuable for taxpayers who have invested in hedge funds and other business interests that are not publicly traded. If a donor were to give one of these property interests to a private foundation (the other charitable vehicle that allows a donor to have ongoing control), only the amount of the initial investment could be deducted. If the donor were to give this interest instead to a DAF, the full current value of the asset could be deducted. For example, if a donor invested $100,000 in a hedge fund, and it grew to be worth $2 million, the donor would get only a $100,000 deduction if it were given to a private foundation, but would get a $2 million deduction if it were given to a DAF. This ability to provide a larger deduction for donations of complex assets has fostered the growth of DAFs. One proponent of DAFs has referred to this ability to exploit these previously untapped resources as an opportunity for “philanthropic fracking.”
This all leads to donors and the DAFs having a much stronger interest in using the money to build up endowments rather than spending the money. It’s another way that the financialization of the American economy has undermined any public good. The authors call for congressional action to redefine the tax rules for charitable donations to help solve these problems. That no doubt makes sense, although it’s unlikely Congress would act to do anything that might inconvenience the wealthy in any way.
Of course the fundamental problem is that the United States has almost always prioritized charity over state action to solve problems of poverty. Other than The Great Exception that started with the Roosevelt administration and ended after 1973, the U.S. has traditionally used private action to provide basic services instead of governmental institutions. Today, Bill Gates matters in public health issues based on the sole criteria that he is very wealthy. That allows him to personally set priorities on these issues. That’s a big problem. Donating money is fine, but setting agendas is not. Moreover, it should be the government taking the lead on many of these issues, not private individuals trying to save their souls after decades of screwing people over to get rich. As I have said before, the moral judgement of the rich is not how they behave once they are rich. It’s how they behaved as they acquired their wealth.
In any case, for a lot of wealthy people, they don’t care as much about what they do with their charitable money as much as they care that a) they get a lot of tax breaks from giving it away and b) they can say they’ve donated money because no one is really going to check up on it, so long as they don’t run for president.