Competition And Commerciality
What is nonprofit / for-profit competition all about?
Like any well-structured civil society, the United States is composed of three fundamental sectors: a for profit, commercial, business sector; a nonprofit sector; and a governmental sector. A robust democratic society necessitates the presence and effective functioning of these three sectors, each operating to its fullest potential within suitable and well-defined boundaries. The vibrancy and health of these sectors significantly enhance and maintain personal freedoms.
By definition and necessity, this tripartite societal structure inevitably produces friction, as the sectors often clash. There is a continuous and ongoing struggle over the determination of what constitutes the “suitable boundaries” for each sector. These resulting conflicts revolve around the allocation of functions and responsibilities to the appropriate sector. A cursory examination of the current state of the U.S. healthcare delivery system vividly illustrates the intensity and scope of these sectoral battles.
For the most part, these issues are policy determinations that need to be resolved by lawmakers, including those in all three branches of government—legislative, executive, and judicial. In this context, there is very little in the way of formal legal constraints, other than those designed to prevent transgressions against federal public policy, constitutional law principles, or, perhaps, state law regulations. Although this is the intended manner in which the system is supposed to operate, these sectoral struggles generate significant problems for nonprofit organizations.
A prevailing general principle is that nonprofit organizations are expected to remain “in their place.” The U.S. economic system is still predominantly based on the principles of capitalism. Consequently, for-profit organizations are generally treated more favorably in matters of sectoral clashes than nonprofit organizations. It is generally considered inappropriate for nonprofit organizations to engage in activities that are typically conducted by for-profit organizations. The prevailing preference is that if for-profit entities undertake certain activities, then nonprofit organizations should refrain from doing so.
Conceptually, under this mode of thinking, nonprofit organizations are not supposed to engage in activities that are being performed by for-profit organizations. Likewise, if for-profit organizations decide to enter a field that has traditionally been the domain of nonprofit organizations, the nonprofits are expected to retreat from that field. In general, nonprofit entities—particularly charitable organizations—are often expected to limit their engagement to functions that have been conceded to them by the for-profit sector (and possibly the governmental sector).
What is the problem with nonprofit/for-profit competition?
The issue at hand is fundamentally an economic one. Typically, nonprofit organizations benefit from tax-exempt status. This implies that taxes do not constitute a part of the entity’s operational costs. Assuming that all other expenses are equivalent to those of their for-profit counterparts, the tax-exempt nonprofit entity is able to engage in competitive activities with a lower overall cost of operations. In an effort to attract customers and expand market share, a nonprofit organization can transfer the reduced operational costs to customers through lower pricing. Consequently, this can lead to a situation where both a nonprofit organization and a for-profit organization are performing the same activities for public consumption—whether through the sale of goods or the provision of services—with the nonprofit entity offering these at a lower price.
Typically, critics from the for-profit sector accuse nonprofit organizations of engaging in unfair competition. When this term is employed, the complainants are asserting that the pricing strategies of nonprofit organizations are undermining the sales of goods or services by for-profit organizations. The central issue in these complaints is the utilization of tax-exempt status by nonprofits to reduce prices, thereby creating an uneven playing field in competition with for-profits.
A secondary concern arises from the belief that consumers, when given the choice to purchase a good or service from either a nonprofit or a for-profit entity, will prefer the former. This perspective suggests that consumers feel more comfortable purchasing items from a nonprofit organization, as there appears to be a greater element of trust involved. This phenomenon, which serves as the basis for claims that nonprofit organizations should not engage in certain commercial endeavors, is referred to as the halo effect.
Is this form of competition common?
The situation is becoming increasingly prevalent, and the practice is experiencing substantial growth. Essentially, there are two primary forms of competition between nonprofit and for-profit entities.
The first form occurs when the core activities of nonprofit organizations inherently compete with those of for-profit organizations. A notable example of this can be found in the healthcare sector, where some hospitals and other healthcare providers operate as nonprofit entities, while others function as for-profit (proprietary) entities. This situation predictably generates significant debate regarding whether nonprofit hospitals should maintain their tax-exempt status or if it should be significantly restricted. Other sectors where this dual presence is observed include educational institutions, publishing entities, various types of consulting firms, insurance providers, and financial institutions.
However, most of the criticism in this area pertains to the second form of competition. This occurs when a nonprofit organization primarily engages in tax-exempt activities (which are typically non-competitive) but selectively participates in one or more competitive functions. One of the most controversial contemporary examples of this issue is seen in the travel industry. The travel sector faces significant challenges due to competitive tours being packaged and sold by tax-exempt entities such as religious organizations (including churches), universities, colleges, alumni associations, and similar institutions, often under the guise of educational expenses.
Has Congress responded to these complaints about unfair competition?
The principal response to this issue has been the formulation of the unrelated business income rules. Congress enacted these rules over 55 years ago as a major component of the Revenue Act of 1950. These rules were specifically devised to eliminate the potential for unfair competition between nonprofit and for-profit organizations.
The aim was, or was believed to be, to place the unrelated business activities of exempt organizations on the same tax basis as those conducted by for-profit entities when both are in competition. The essence of this body of law is to separate the income of a tax-exempt organization into two distinct categories: income derived from related business activities and income derived from unrelated business activities. The rationale behind this separation is that by taxing the income generated from unrelated business activities, the pricing differential that can lead to unfair competition is effectively removed. This approach is commonly referred to as leveling the playing field.