Scott Hodge has been one of the nation’s leading experts on tax policy, the federal budget, and government spending for decades. From 2000 to 2022, he served as president and CEO of the prestigious Tax Foundation in Washington, DC. Today, he is president emeritus and senior policy adviser.

His new book Taxocracy: What you don’t know about taxes and how they affect your daily life describes and comprehensively analyzes the many ways in which taxes – separately and apart from merely raising money for the government – cause us to do things we would not normally do, or not to do things we would normally do.

Taxocracy also contains an informative chapter on the effects of certain Shortage of taxes – exemption from tax liability for certain purposes. “Perhaps contradictorily, there are times when not taxing something can distort the economy just as much as taxing it,” Hodge begins the chapter.

“Don’t get me wrong: This is not an argument for taxing everything,” he warns. “It is a plea for tax parity and what economists call tax neutrality.”

Hodge therefore examines the tax exemption for non-profit organizations in both Taxocracy and, in more detail, an important and timely new paper from the Tax Foundation entitled “Reigning in America’s $3.3 Trillion Tax-Exempt Economy.”

“For over a century, lawmakers have exempted politically favored organizations and industries from the tax code,” he writes in the paper. “As a result, the tax-exempt nonprofit economy now accounts for 15 percent of GDP, includes more than 1.8 million organizations, and manages over $8 trillion in assets. In 2019, it generated over $238 billion in net income.”

“The tax-exempt sector is in dire need of review and reform,” Hodge continues. “The U.S. needs a principles-based, rules-based approach to 1) distinguish between charities and tax-exempt entities and 2) create a level playing field for nonprofits and for-profits to do business.”

He recommends a “sensible revision of the tax exemption rules”. To do this, “the definition of ‘public charity’ must be narrowed and all non-charitable income must be subject to the corporate tax rate of 21 percent”.

Jack Salmon, director of policy research at the Philanthropy Roundtable, responded to Hodges’ recommendations by saying they “overlook the clearly mission-driven nature and reinvestment practices of nonprofits” and would amount to “punishing American citizens by taxing their constitutionally protected right to free association.”

The even-tempered and good-natured Hodge was kind enough to sit down for a recorded conversation with me last week. In the first part of our discussion, which you can find here, we talk about the tax-exempt economy, narrowing the definition of “public charity” in tax law, and subjecting supposedly nonprofit organizations to tax neutrality.

The nearly 14-minute video below is the second part, where we discuss the general way in which tax neutrality should be applied to nonprofits’ business income and the benefits it brings to economic growth.

“I’ve had this discussion with members of Congress,” Hodge tells me, “because there’s interest in it. They’ve held hearings on nonprofit hospitals, there have been some hearings on credit unions in the past. I want them to set ground rules that apply across the board, rather than trying to target specific industries.”

Hodge acknowledges that there has been a big recent tendency among conservatives to consider policy reforms with respect to nonprofits, including universities, that are “woke” or defend and perhaps even promote Hamas activities. “But I would prefer that we apply rules that are universal, so that it doesn’t look like we’re cherry-picking and going after the weakest link or the link that gets us the most political attention,” he says. “I think the rules need to be uniform and universal, so that no one feels victimized and everyone feels like there’s at least a level playing field.”

By and large, the huge and growing nonprofit economy is “completely outside the income tax system,” according to Hodge. “When we consider fundamental tax reform, we have to try to bring that back into the tax base to achieve … fairness, increased revenues and some degree of equity.”

With most of the individual provisions of the Tax Cuts and Jobs Act of 2017 expiring next year, he says:

There are many members on both sides of the aisle who want to raise the corporate tax, which would be very damaging, or raise taxes on small businesses or what we call pass-through businesses. Both would be bad economic policy, bad tax policy. But if we broaden the tax base to include this nonprofit sector, we can avoid raising taxes on other sectors that would be even more damaging. If we get some balance between industries, that would ultimately be growth-enhancing.

This article first appeared in the Giving Review on August 13, 2024.