Document Type

Article

Publication Title

New York Law School Law Review

Abstract

The best known account in recent legal or economic literature of why certain organizations use the nonprofit form, and when or why they ought to be tax-exempt, comes from Henry Hansmann. Hansmann argues that the nonprofit form prevails where it does because it responds efficiently to problems of "contract failure" where behavior is hard to monitor. For example, I might not trust a for-profit company to use my donation to provide famine relief in a foreign country or to render "complex personal services" such as nursing care, given the difficulty of observing performance directly. The nonprofit structure is supposed to increase one's confidence in the company's good-faith behavior. Hansmann further argues that the nonprofit form can lead to inefficient under-investment in the sectors to which it is best suited, since nonprofits cannot attract conventional equity capital and have difficulty even attracting sufficient loan capital. Tax exemption could be seen as responding to this inefficiency by allowing nonprofits to keep more of whatever cash they nonetheless succeed in attracting. How well do Hansmann's arguments hold up after close to twenty years? Overall, I would say they hold up well, but they are better at explaining nonprofits than at supporting tax exemption. Moreover, Hansmann mainly emphasizes only one of the two key characteristics that nonprofit organizations generally share. In addition to being nonprofit in form, they generally provide services in fields that have a certain aura of virtue or public-spiritedness, making the word "charitable" not wholly inapposite. Consider § 501(c)(3) of the Internal Revenue Code, which lists the following exempt purposes: religious, charitable, scientific, testing for public safety, literary, educational, and prevention of cruelty to children or animals. The nonprofit field was characterized by this focus on charity, virtue, or public-spiritedness even before the income tax created incentives for the link. Surely both of the typical nonprofit's two key defining characteristics are important, and perhaps the greatest interest lies in explaining their overlap.

First Page

1001

Volume

41

Publication Date

1997

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