The Role of Charity in a Federal System

ABSTRACT This Article critiques the prevailing justification for subsidies for the charitable sector and suggests a new alternative. Existing rationales are based on an economic model that assumes a single government whose decisions are guided by a single median voter. I argue that this theory is unpersuasive when translated to federal systems, such as the United States, in which there may instead be thousands of competing local governments. I then attempt to construct a theory of the charitable sector that takes account of interactions between charity, local government, and national government. In this revised account, charity is most important when federalism mechanisms break down. For example, frictions on exit produce too little jurisdictional competition, and excessively easy exit produces too much competition---a race to the bottom. In both these cases, the quality of the resulting government services is predictably low, so that charity can be expected to outperform rival governments. Even if not, the threat of the charitable alternative may supply competition that is otherwise missing from the market for government services. These conclusions also have implications for the law of charitable organizations, as I detail. TABLE OF CONTENTS INTRODUCTION I. THEORIES OF THE SUBSIDY FOR CHARITY II. INADEQUACY OF CURRENT THEORIES OF THE DEDUCTION A. Government Failure and Multiple Jurisdictions 1. Tiebout and Inframarginal Donors 2. Distortionary Effects of Subsidized Charity in Federal Systems B. Government Failure and Multiple Tiers of Government C. Government Failure and Public Choice 1. The Public Choice Critique 2. Exceptions to the Critique D. Other Rationales for Deduction 1. Federalism 2. Public Choice E. An Overview So Far III. QUALITY OF OUTPUTS A. Imperfect Horizontal Competition 1. Charity as a Substitute for Intergovernmental Competition 2. Counterarguments: Irrelevant Exit and Crowd-Out B. Inadequate Vertical Competition C. Excess Competition D. Warm Glow E. Treasury Efficiency F. Some General Objections G. Summary IV. TOWARDS A NEW FOUNDATION FOR CHARITY A. What is "Charity" Under a Comparative-Advantage Rationale? 1. Exit Costs 2. Broad-Based Services a. Vertical Competition b. Horizontal Competition c. Public vs. Private Goods 3. Redistribution 4. Objections to Weisbrod, Reconsidered 5. A Summary, and Two Examples B. Establishing Charitable Status C. Dangers of Discretion? CONCLUSION INTRODUCTION Our contemporary theory of charity is simple and widely accepted, but incomplete. According to the dominant account, charity exists to provide goods and services that could not readily be produced in the for-profit sector. (1) Typically, in this story, the market fails because the products are public goods--their use by one person does not preclude their use by many others, so that no one person has any reason to pay for them herself. (2) Subsidies, such as the deduction for contributions to charity offered by [section] 170 of the Tax Code, (3) help to prop up the charitable production of these public goods. (4) This same story of market failure is traditionally the basis of the economic rationale for government. (5) Theorists distinguish charity from government by arguing that government meets only the needs of the majority, whereas charity can offer a diverse array of services for all segments of society. (6) But as I will argue here, this supposed advantage of charity assumes that we have only one government, one majority. To the contrary, our federal system is designed to offer precisely the pluralism, flexibility, and responsiveness that charity theorists call for. (7) Thus, in this Article, I argue that we must reconsider charity from the ground up: in a world where both local governments and charities can provide public goods, and government has massive advantages in scale and fundraising, what role is there for charity? …