CityLaw: Three Policy Questions for Nonprofit Property Tax Exemptions

A long-standing feature of American tax policy is the exemption granted to nonprofit organizations, the largest of which is the exemption from local property taxes. The exemption, with origins back to the 18^th century, is widespread. Among the 50 states, 17 state constitutions mandate property tax exemptions for charitable organizations, 25 authorize the legislature to give exemptions, and eight do not address the issue. New York State establishes two classes of exemptions for nonprofits:  mandatory property tax exemptions apply to religious, educational, hospital, mental health and certain other charitable institutions; permissive exemptions are given to most other nonprofits, but localities may remove them. New York City has not passed any limiting local legislation.

In New York City the property tax exemption costs the City in excess of $1.8 billion annually in foregone revenue. Religions institutions represent about $.5 billion of that sum. The property tax exemption for religious institutions is deeply rooted in early decisions by the states to avoid interfering with the practice of religion; taxing houses of worship was seen as potentially being hostile to religious organizations. The exemptions for hospitals, educational institutions, arts and cultural institutions and other categories of exempt organizations, however, are based on different policy objectives. These other exemptions comprise a huge public subsidy; their large size merits an informed and civil discussion of the values sought and achieved by extending the property tax exemption to many non-religious institutions.

The nonprofit sector

In recent decades nonprofit organizations have become more numerous, larger, more dependent on government financing and less dependent on donations. They are also more diverse in their missions, and more competitive with for-profit enterprises. These trends are evident in New York City. Based on data from 2012, more than 42,000 nonprofit organizations are located in the City. Nonprofit organizations earned annual revenues of nearly $134 billion, a figure that increased 26 percent in the decade from 2002 to 2012. In terms of dollar value, the nonprofit sector comprises about one-fifth of the local economy and about one-sixth all local jobs.

For fiscal year 2012 nearly 12,000 New York City properties enjoyed a property tax exemption.  The estimated market value of these properties was $39.5 billion. The $1.8 billion foregone tax revenue for New York City was about 9 percent of the City’s total property tax levy. When property owned by religious organizations is excluded, the remaining nearly 6,000 properties have market value of about $29 billion and the foregone revenue is above $1.3 billion.  These estimates are conservative. Assessed valuations of exempt properties are notoriously inaccurate. For example, in late 2012 the nonprofit Century Foundation sold the Upper East Side townhouse that was its headquarters for $25 million; the Finance Department’s estimate of the market value at the time was just over $4.2 million.

A relatively small number of large property owners account for the bulk of the property tax revenue foregone due to exemptions. If a threshold of $10 million in property market value is applied, just 666 large nonprofit organizations owning properties above that threshold account for nearly two-thirds of the foregone revenue. These large nonprofit organizations should be the focus of any reconsideration of the property tax exemption in order to avoid hardships for smaller nonprofit organizations while still affecting most of the current revenue losses. Such reconsideration should address three questions.

1. Do the missions of large nonprofit organizations receiving exemptions require a public subsidy?

The 666 large nonprofit, non-religious organizations collectively hold exempt properties valued at nearly $20.8 billion. The holdings can be grouped into five categories: health institutions account for 41 percent; education institutions account for 33 percent; housing accounts for 11 percent; art and cultural institutions 9 percent; and social services and other philanthropies 6 percent.

Economic theory and common sense argue for public subsidies to organizations on two grounds. First, the mission of the organization provides essential services to individuals who otherwise could not afford them. Government support for food, shelter and medical care for the indigent are widely accepted examples.

Second, the mission of the organization provides services that benefit all or most members of society in addition to the specific individuals served. These “positive externalities” improve overall social welfare and would be underprovided in the absence of public subsidies. For example, higher education results in benefits to many members of society beyond the individual taking courses; widespread benefits include those from a more productive labor force and more informed electorate

Among the five categories of large exempt properties, the missions of two categories may not warrant a subsidy – housing and arts and cultural facilities.

Housing. Housing is typically provided by private landlords and is subject to property taxes. However, the nonprofit exemption has been extended to housing owned by universities and hospitals. The 17 institutions with housing valued at more than $10 million include eight universities and nine hospitals with Columbia University ($646 million) the largest university and New York Presbyterian ($367 million) the largest hospital. The number of exempt housing units approaches 15,000 and the average per unit subsidy reaches as much as $15,690 annually at New York University.

Do these subsidies aid the poor or support positive externalities? If the benefit is given to the residents in the form of lower rents, then this does not serve the goal of aiding the poor well. It gives benefits as high as $15,690 annually, not taxable as income, to the faculty, doctors, nurses and out-of-city students at private colleges in the exempt units; they typically have incomes well above those of households renting from tax-paying landlords and not getting any tax benefit. To illustrate, the median annual salary of the lowest ranked faculty (assistant professors) at the institutions with the greatest amount of exempt property (Columbia University and New York University) is $99,000 and $99,700, respectively; these salaries, which are often combined with the earnings of another member of the household, are well above the median income of others occupying rental housing in the City, $38,447. Similarly, if the intended goal is to support the positive externalities of higher education, the impact is at best weak. Broad educational benefits are created only if (a) the subsidy given to the faculty or students is necessary to enable them to pursue their education or academic career, or (b) the university charged the faculty or students market rents and retained the extra rental income to support its general budget. Neither condition is typically the case

Art and cultural facilities. Among the more than 400 nonprofit art and cultural exempt properties within New York City, 27 organizations have property valued at more than $10 million and these properties account for the vast majority of exempt value in New York City. By far, the largest owner is Lincoln Center with facilities valued at $1.1 billion and a tax benefit of $50.6 million annually. Its constituent organizations, including the Metropolitan Opera and Philharmonic Orchestra, have combined annual revenue of about $849 million; the tax benefit equals six percent of this revenue.

The other owners of high value cultural properties include eleven museums whose properties range in value from the Museum of Modern Art ($334 million) to the Museum of Art and Design ($10.7 million). The tax benefit ranges from the equivalent of nearly 35 percent of annual revenue at the Staten Island Historical Society to one percent of annual revenue at the Whitney Museum. The Metropolitan Museum of Art, the Museum of Natural History and the Brooklyn Academy of Music are not counted among the properties having a nonprofit exemption because they are City-owned. They are operated by nonprofit organizations, but the facilities are owned by the City of New York.

The justification commonly given for the subsidy to nonprofit cultural institutions is that they attract visitors from other jurisdictions and add to the tax base through the added spending of these visitors. Unquestionably the cultural institutions draw visitors from out of town and yield economic benefits for the City; however, the property tax exemption is probably not essential to these organizations’ ability to draw out-of-towners. If it were necessary to increase admission prices to offset property tax levies, that would not deter many of the current visitors. To illustrate, among the major museums with property tax exemptions, the tax benefit per visitor averaged $5.50; even if this entire subsidy were offset by admission fee increases, the impact on the volume of domestic and international visitors (who spend an average of $621 and $1,470, respectively, per trip) is likely to be very modest.

2. Should the subsidy be funded from local tax sources or from state or federal revenues?

For subsidies intended to meet the needs of the poor, the subsidy should draw on the broadest tax base – the national government. This is appropriate because the desire to avoid hardships is widely shared and rooted in common feelings of membership in a single nation. (For example, “No American should go hungry or homeless.”) Some states establish more generous norms than the national standard because their residents value these benefits, and those supplemental efforts are supported by state taxes. (For example, higher cash welfare benefits or more generous Medicaid eligibility rules.)

For subsidies intended to deal with benefits to a broader population (“positive externalities”), determining the fiscal responsibility of each level of government can be difficult. The guiding principle relates to how wide a population is affected. Where the benefits are widespread, the tax base should be broad; where the benefits are restricted to certain areas or populations, the tax base should be correspondingly narrow. Thus for subsidies to medical research, the appropriate tax base is national; in contrast, support for local parks or recreation centers should come from a tax base reflecting the smaller jurisdiction in which beneficiaries reside. Accordingly, not all activities requiring a subsidy should receive a local subsidy.

A local subsidy is least appropriate for higher education. Among the 193 educational properties valued at least $10 million are 28 higher educational institutions with property worth a total of nearly $5.0 billion, excluding the housing discussed earlier. The subsidy to private higher education is about $228 million annually.

Is a local subsidy of this scale appropriate? In the United States public support for higher education is provided predominantly by state governments. The federal government provides student loans and research grants, but states operate and fund large public university systems. New York follows this pattern. The State funds the large SUNY system with appropriations now about $1.3 billion annually, and it provides about $1.4 billion to support the CUNY system. In addition the state gives students tuition assistance grants; of the $935 million total about 65 percent is for students going to public universities and $330 million helps students pay private college tuition. Only about $35 million in unrestricted aid is given annually by the State directly to private universities.

Local governments are rarely major funders of higher education. New York State is an exception in its expectation that counties and New York City pay a significant portion of the cost of community colleges; New York City appropriates about $327 million annually for its share of the CUNY community colleges expenses.

In this fiscal context the relatively large annual local subsidy through the property tax exemption of $228 million to private higher education is an anomaly. It is more than the State provides in unrestricted aid to private higher education and more than two-thirds the sum the City provides to its pubic community colleges serving almost exclusively local residents.

For social service and health institutions the analysis is different. The typical pattern in the United States is for social service and health missions to be funded predominantly with federal and state funds. The Medicaid and Medicare programs as well as many cash assistance, food stamp and homeless programs follow this pattern. But New York City is distinctive in setting higher goals for aid to the needy, and it has been willing to support financially the nobler standards. Its extensive social service network and large municipal hospital system are examples. In this sense the property tax exemption for nonprofit health and social service institutions fits the City’s objectives.

3. Are there more effective ways to provide a local public subsidy than through property tax exemptions?

If one accepts the merits of a local subsidy for certain functions including health and social services, the remaining question is whether a property tax exemption is the best mechanism for delivering the subsidy. Assuming the goal of the subsidy is to promote the volume and quality of the benefiting services, the size of the subsidy should vary with the scale or quality of the services the organization provides. This is not the case for the property tax exemption.

The property tax exemption provides a subsidy linked to the value of property alone, which may not be related to the volume or quality of the service which the local government is seeking to promote.  For example, in New York City, the property tax exemption gives greater subsidies to organizations based in Manhattan, where property values are highest, than to those based in the other boroughs regardless of whether or not the Manhattan-based organization is providing more services. A broader point is that giving a subsidy based on the value of property owned is inherently inefficient and creates perverse incentives. It discourages organizations from renting and encourages excessive ownership of land and facilities.

Two better options are available and already used. First, subsidies can be delivered via contracts rather than tax exemptions. New York City already contracts with nonprofits for a variety of human services with the payment conditioned on delivery of service rather than ownership of property. The current tax exemption subsidy could be converted to direct expenditures and allocated more effectively through the annual budget.

Second, the exemption can be conditioned on provision of community benefits at least equal to the tax subsidy. This approach has been taken in federal legislation and in six states. The federal Affordable Care Act includes standards for nonprofit hospitals seeking income tax exemptions as charitable institutions; hospitals are required to conduct a community health needs assessment at least once every three years, establish written financial assistance and emergency medical care policies and limit the amounts charged to individuals eligible for assistance under the policy. Community benefit standards in six states vary but are practical models. Illinois in 2012 enacted the most rigorous criteria; it requires hospitals provide benefits equal to the value of the property tax exemption and that the benefits take the form of charity care, subsidies to low income individuals or other substitutes for state and local government responsibilities.

Raising these three questions is intended to be thought provoking, and the answers suggested are tentative rather than definitive. But the stakes are big – more than a billion dollars of taxpayers’ money and the future of some of the most well-known institutions in the city and the nation. Political pressure to reconsider the nonprofit tax exemption is likely to become intense when an economic slowdown puts a squeeze on the municipal budget; in the interim, informed and civil discussion of the issue ought to precede and anticipate those more stressful times.  Nonprofit leaders should have an opportunity to voice their concerns about any proposed changes and correct any misunderstandings. Suitable forums such as City Council hearings or a mayoral commission can lay an evidence-based and well-reasoned foundation for making future decisions. Our elected leaders should begin the process of rethinking this element of tax policy so that wise choices can be made when the issue rises on the public agenda.

Charles Brecher is Professor Emeritus, Robert F. Wagner Graduate School of Public Service, New York University and Consulting Co-Research Director, Citizens Budget Commission. Thad Calabrese is Assistant Professor, Robert F. Wagner Graduate School of Public Service, New York University. The views expressed are not necessarily those of New York University or the Citizens Budget Commission.