Pay now or pay later

While US nonprofits are concerned that American foundations, even the Bill and Melinda Gates Foundation, are having to rein in grant programmes for next year to reflect the hit that their endowments have taken in the financial crisis, charities in Britain have even more to be worried about.

As Matthew argues today in the Guardian, American nonprofits have the reassurance that foundations will have to meet a legal obligation to pay out at least 5% of the value of their (diminished) endowments.  In contrast, UK and European foundations face no such requirement.  In practice, as we describe in the book, few foundations in Britain and Europe give away 5% a year and some give away virtually nothing.  In these troubled economic times, some may be tempted to cut funding further to try to protect their endowments.  That would compound the charities’ funding problems when they probably need the money most.

The absence of a ‘payout rule’ in Britain and Europe also means that foundations don’t face the same incentives to maximise investment returns.  According to research from the Institute for Philanthropy published earlier this year, this is costing British foundations £750 million a year in investment income.

The Rosenwald and Olin Foundations are notable examples from the US where the donor decided to ‘spend out’ the endowment to give more today rather than giving a smaller sum in perpetuity. A couple of years ago, the trustees of the Princess Diana Memorial Trust in the UK made the same decision. Other donors prefer to retain the capacity to give to meet the needs of the day after the day after tomorrow. Indeed, philanthropists in Tudor England pioneered this idea 500 years ago because they had to spend to recapitalise hospitals and schools that he been created by the Church in the Middle Ages but had run out of cash.

There’s no right answer to the question of whether to give in perpeuity or allow your foundation to spend out. But philanthropy is tax-subsidised so it seems reasonable for the taxpayer to expect a reasonable return of public benefit for the contribution he is making. The 5% rule strikes a balance between the public good and donor freedom, maybe it’s time to bring it across the Atlantic.