Nonprofit Sector: Increasing Numbers and Key Role in Delivering Federal Services
Published: 2007-07-24T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The nonprofit sector is an important means through which public services are delivered and national goals addressed. The federal government increasingly relies on networks, often involving nonprofits that address many issues--health care, education, and human services, for example. Because nonprofit organizations play a key role as partners with the federal government, there is a need to better understand the sector. This testimony (1) provides a picture of the nonprofit sector--its size, composition, and role in the economy; (2) discusses how and why the federal government partners with the sector; and (3) identifies issues related to the sector as a federal partner that need to be better understood. GAO's preliminary work on this topic focused on the intersection of nonprofit organizations and the federal government, including trends, the use of federal funding, and emerging issues. GAO interviewed key experts from relevant associations and academia, reviewed related research, and hosted roundtable discussions with key researchers and practitioners in the nonprofit area.
section_title: What GAO Found
paragraphs: U.S. nonprofit organizations have a significant role both in the economy as awhole and as providers of services. While the majority of nonprofit organizations have relatively small operating budgets, together their impact is large. For example, researchers estimate that the sector's spending in recent years was roughly 11 to 12 percent of the nation's gross domestic product and, in 2002, the sector had over 9.6 million employees, about 9 percent of the civilian workforce. Further, the sector has grown; the number of charitable organizations reporting almost tripled over the last two decades. The federal government increasingly partners with nonprofit organizations as they bring many strengths to these partnerships, such as flexibility to respond to needs and access to those needing services. These organizations receive significant funds from government sources to provide services. Researchers have attempted to quantify these funds. For example, one estimate is that the federal government spent about $317 billion on nonprofit organizations in fiscal year 2004. However, the lack of data makes measuring federal funds to nonprofit organizations difficult. Many funds come through indirect routes, such as through state and local government, adding to the difficulty of determining funding and measuring performance. Although IRS is generally responsible for overseeing the tax-exempt status of these organizations, there is less focus at the federal level on the comprehensive role of nonprofits in providing services using federal funds. Our preliminary look at how the federal government interacts with the nonprofit sector indicates that several policy issues have emerged, for example: (1) Coordination and collaboration--the increasing importance of collaboration between all levels of the government and nonprofit organizations. (2) Internal governance issues--the need to strengthen internal governance of nonprofit organizations. (3) Capacity--the need to improve smaller nonprofit organizations' capacity to address weaknesses in finances, administration, and human capital. (4) Nonprofit sector data--the need for improved data on the sector's size, financial status, and funds from federal sources. (5) Administrative and reporting requirements--the many requirements to be accountable, which while important and necessary, require information in different formats and with increasing complexity. (6) Fiscal challenges for nonprofits--the instability of some nonprofits' financial position. At the request of the Congress, we are beginning work to examine these issuesfurther.

section_title: Letter
paragraphs: I appreciate the opportunity to participate in today’s hearing to discuss our  preliminary work and observations on the role the nonprofit sector plays  in partnering with federal, state, and local governments to deliver  programs and services. Although the sector is an important means  through which many key national goals are addressed, its role can be  nearly invisible to federal policy-setting decision makers when designing  and implementing programs. Broadly stated, the federal government  increasingly relies on large and complex networks of nonfederal actors to  carry out initiatives. In recent years, most oversight of the sector has  focused on its tax-exempt status. However, because the nonprofit sector  plays a key role in delivering services funded by the federal government,  there is also a need to better understand the sector as a partner on which  the federal government relies.
The nonprofit sector is defined primarily by its tax-exempt status, a  designation that occurs at both the federal and state levels of government.  In addition, nonprofit organizations share certain other characteristics.  First, they work to serve public purposes or the common goals of their  members. Further, they can benefit from voluntary labor and are self- governing. In addition, they are not permitted to distribute profits to their  members but must instead use them to further the organization’s  charitable purpose. Beyond these commonalities, they have a diverse set  of missions, and many of those missions are related to those of federal  agencies. As a result, it is important to better understand the composition  of the sector, its importance, and its strengths and challenges.
An estimated 1.8 million organizations were recognized as federal-tax- exempt organizations as of September 2006. Of these, about 60 percent  (see fig. 1) are public charities or foundations that benefit the broad public  interest, and are referred to as 501(c)(3) organizations. Our focus today is  largely on charities, as they represent the majority of the sector. (See  further clarification of key terms in app. I.)
501(c)(4)
As you know, the Internal Revenue Service (IRS) serves as the agency that  generally oversees the nonprofit sector at the federal level. IRS focuses on  whether organizations meet tax-exempt requirements and comply with  federal laws, such as those governing the use of funds intended for a  charitable purpose. It approves organizations for federal tax-exempt status  and is the recipient of annual reporting of financial data on Forms 990,  which are required from organizations with gross receipts over $25,000. In  addition, a few other federal organizations, such as the Federal Trade  Commission and the Department of Justice, provide oversight of nonprofit  organizations in certain specialized areas. States also play an important  role in the oversight of nonprofits, as they have interests and  responsibilities in areas such as the legitimacy of charitable fundraising  and whether a charity is meeting the charitable purpose for which it was  created. In addition, the public plays a role in oversight through its ability  to review key information on individual organizations, to the extent useful  information is available.
My testimony today will point out some of the diversity and the range of  characteristics present within the sector, along with some of the issues  that arise as nonprofit organizations interact with the federal government.  I would like to (1) provide a picture of the nonprofit sector—its size,  composition, and role in the economy; (2) discuss how and why the  federal government partners so extensively with the sector; and  (3) identify issues that others have raised related to the sector as a federal  partner that need to better understood.
My statement is based largely on some preliminary work we recently  completed that focused broadly on the intersection of nonprofits and the  federal government. We focused on trends in the use of federal funding  and on identifying emerging issues in the nonprofit sector. We interviewed  representatives from several large nonprofit member associations,  research and advocacy organizations, academic researchers, foundation  representatives, and nonprofit practitioners. We hosted two roundtable  discussions with key researchers and practitioners in the nonprofit area.  We also reviewed literature on the sector from academic centers, research  institutes, foundations, and others to better understand sector trends and  issues, and to identify additional experts for interviews. Our work  included a review of our previous work related to nonprofits on a wide  variety of topics, such as tax policy, human service programs, and  executive compensation. Our work was performed in accordance with  generally accepted government audit standards.
subsections: section_title: Role of Nonprofit Organizations in the Economy and as Providers of Services Is Significant
paragraphs: While the majority of nonprofits individually have relatively small  operating budgets, as a whole, the nonprofit sector has a significant  presence in the U.S. economy, according to researchers of the nonprofit  sector. For example,  In 2004, nonprofit organizations that submitted Forms 990 to IRS held  an estimated $3 trillion in total assets and received $1.4 trillion in  revenues.
During the period 1998 through 2002, spending reported by tax-exempt  entities was roughly 11 to 12 percent of the nation’s gross domestic  product.
The tax-exempt sector had over 9.6 million employees, about 9 percent  of the civilian workforce in 2002.
Wages and salaries paid to nonprofit sector employees comprised 8.3  percent of those paid in the U.S. in 2004.
In addition to representing a significant portion of the U.S. economy, the  sector is growing. Data indicate that from May 2000 to May 2006, the  number of registered public charities has grown over 30 percent from  about 646,000 to about 851,000, although organizations that have gone out  of existence may be included in those numbers. Other data also suggest  growth in the sector. As shown in figure 2, the number of 501(c)(3)  organizations completing the Form 990 has almost tripled over the last two  decades (from 1986 to 2006) from about 148,000 to about 427,000.
Experts have identified several possible contributing reasons for this  increase:    a shift in recent decades away from government providing most  services directly;  the expansion of service-related industries in the U.S., of which many  nonprofits are a part;    deinstitutionalization during the 1960s and 1970s that eliminated large,  public care facilities in favor of smaller, community-based  organizations, often operated by nonprofit entities; and  the trend in devolution in certain policy areas such as welfare, which  contributed to a lessening role of the federal government and more  localized control in the hands of state, local, and nonprofit  organizations.
Nonprofit organizations are found in a wide variety of policy areas such as  health care, education, and human services, and include many prominent  and highly visible community institutions, such as hospitals, museums, job  training centers, and churches. (See a list of categories in app. 2.) These  organizations also represent a diverse range of sizes. According to the  Independent Sector, 73 percent had annual budgets of less than $500,000  in 2004 and only 4 percent had budgets exceeding $10 million.
Much of the data on the sector come from the IRS Form 990, but those  data have limitations. For example, returned Forms 990 are sometimes  incomplete or inaccurate and are not consistently followed up on, and  some nonprofit organizations required to submit Forms 990 do not do so.  In addition, for certain types of funding, the Form 990 does not distinguish  between government and private sources of support. It also does not  break out the sources of government grants by federal, state, or local level.  We have pointed out in the past the importance of requiring information in  a more timely and user-friendly way on IRS Forms 990.
section_title: Federal Government Increasingly Partnering with Nonprofit Organizations
paragraphs: Nonprofit organizations bring many strengths to their partnerships with  the federal government. Their breadth and diversity allow the sector to  address the specific needs of communities and of individuals. Researchers  commenting on the advantages of nonprofits point out the provision of  benefits in the public interest, often with greater flexibility and access than  can be achieved by the public sector. Nonprofits often bring an indepth  understanding of a particular geographic area or special population and  have access to underserved populations.
Nonprofit organizations play a large and increasing role in delivering  services traditionally provided by the government, according to  researchers. Their research indicates that nonprofit organizations receive  significant funds from government sources and that over time these funds  have increased. As we previously noted, data are limited but researchers  have attempted to analyze data from various sources and identify trends in  federal funding to nonprofits. Their work offers a glimpse into the  magnitude of federal funds going to nonprofits, but does not provide a  comprehensive analysis of the various funding streams. For example:    Researchers have reported that the federal government provided about  $115 billion directly to nonprofits in fiscal year 2001, the majority of  which hospitals received through the Medicare program. Indirect  federal funds through state and local governments to nonprofits were  an estimated $84 billion, totaling about $199 billion, or about 15 percent  of federal payments and grants.
Data from other researchers indicate that the federal government spent  an estimated $317 billion on nonprofit organizations in fiscal year  2004.
Researchers estimate that federal support to nonprofit organizations  increased more than 230 percent from fiscal year 1980 to fiscal year  2004 in adjusted dollars.
Federal funds reach nonprofit organizations through many paths (see fig.  3). Some flow directly from federal agencies to nonprofit organizations,  such as research grants to universities. Some funds flow to states as  grants, whose funds may flow to nonprofit organizations, or may flow to  local governments that compensate nonprofit organizations for services  with those funds. Also, some federal funds move to nonprofits on the basis  of individuals’ decisions, that is, from federal programs to nonprofits  selected by the consumer, such as for health care. In addition to direct and  indirect federal funds, nonprofit organizations benefit from being tax- exempt and also from other tax policies, such as donors’ ability to deduct  contributions on their taxes.
section_title: Emerging Policy Issues and Challenges Facing the Nonprofit Sector
paragraphs: The current federal oversight of nonprofits is focused on organizations’  tax-exempt status and on specific programs. However, there is less focus  on understanding the overall role of nonprofits as implementers of  national and federal initiatives, and how to best ensure that nonprofits  have the support they need. As we spoke with researchers and  practitioners, several issues emerged as needing attention in order to  ensure the strength of this important partner to the federal government.  We have looked at specific issues involving nonprofit organizations over  the years, but our past work was largely related to specific programs. We  heard several common issues while taking this more comprehensive look  at nonprofit organizations’ interaction with the federal government (see  fig. 4).
Coordination and collaboration—One theme that surfaced in our  preliminary research was the importance and value of coordination and  collaboration between nonprofit organizations and government at all  levels. As we pointed out in our work on 21st century challenges, the  government relies increasingly on new networks and partnerships to  achieve critical results and develop public policy, often including multiple  federal agencies, non- or quasi-government organizations, for-profit and  nonprofit contractors, and state and local governments. A complex  network of governmental and nongovernmental entities shape the actual  outcomes achieved, whether it be through formal partnerships in grant  programs or through independent actions of each addressing common  problems. For example, our research on disaster relief efforts following  September 11 and Hurricanes Rita and Katrina highlighted the role of  nonprofits in providing assistance and the importance of communication  and coordination of services with government entities. We pointed out that  the scope and complexity of the September 11 attacks presented  challenges to charities in their attempts to provide seamless social  services for surviving family members and others in need of aid. With  regards to the response to Hurricanes Katrina and Rita, we noted that  charities could improve coordination among charities and the Federal  Emergency Management Agency.
We believe that many of the key practices that help enhance and sustain  collaboration among federal agencies can be helpful between government  and nonprofit organizations, such as when both parties collaborate to    define and articulate a common outcome;    establish mutually reinforcing or joint strategies;   identify and address needs by leveraging resources;    agree upon roles and responsibilities;    establish compatible policies, procedures, and other means to operate    develop mechanisms to monitor, evaluate, and report the results of  collaborative efforts;  reinforce accountability for collaborative efforts through plans and  reports; and  reinforce individual accountability for collaborative efforts through  performance management systems.
Internal governance issues—A second theme that surfaced in our  preliminary research was the need to strengthen governance of nonprofit  organizations, a point made by the sector itself as well as by others. At the  organization level, a sound governance structure can establish the set of  checks and balances that help steer an entity toward result-oriented  outcomes consistent with their purposes while also guarding against  abuses. Concerns about accountability and transparency of nonprofit  organizations have grown in recent years. In 2004 and 2005, the Senate  Finance Committee held hearings to look more closely at practices that  are illegal or not in keeping with standards typical of the charitable sector,  and released a discussion draft of possible solutions. In October 2004, the  Independent Sector convened a panel, whose report made several  recommendations to address concerns. The panel continues to focus on  self-regulation as a way to address these concerns, although there are  mixed opinions on the potential success of self-regulation. In addition,  several efforts are under way within the sector to raise awareness of ways  to improve internal governance of nonprofits, including associations  focusing on providing training or consulting, and national certification  processes.
Capacity—Another area to which researchers suggest attention should be  paid is improving the capacity that smaller nonprofit organizations have to  address weaknesses in finances, administration, and human capital. Many  nonprofits struggling to accomplish their mission on limited budgets lack  the resources that could allow them to better manage their finances and  strengthen their infrastructure. In addition, particularly in smaller  nonprofit organizations, the strengths of board members may be in  addressing their organization’s mission, and they may lack legal and  financial knowledge or the skills necessary to oversee a nonprofit entity.  One specific area identified as needing attention is the development of  human capital, as these organizations need to address a complex set of  issues, such as competition for service workers, leadership succession,  and staff turnover. One promising change is the increase in graduate  programs offering a concentration in nonprofit management from 17 in  1990 to 97 in 2001. While there has not been a comprehensive effort by  the federal government to improve the capacity of nonprofit organizations,  several federal programs provide capacity-building grant funding and  technical assistance to nonprofits. Providing assistance to improve  capacity may be one area where the federal government could employ a  more strategic approach.
Nonprofit sector data – As I mentioned earlier, there is a lack of  sufficient knowledge on a key federal government partner and its role.
Researchers point out that without better data on the nonprofit sector as a  whole, appropriate and timely policy decisions regarding nonprofits  cannot be made. Some actions under way may improve information on  tax-exempt organizations. Beginning in 2008, small tax-exempt  organizations that previously were not required to file Form 990 returns,  with some exceptions (such as churches) will be required to file a shorter  notification form electronically. In July 2007, IRS began mailing  educational letters to over 650,000 small tax-exempt organizations that  may be required to submit the notice. Further, IRS is seeking comments on  a redesigned Form 990, intended to provide a realistic picture of  organizations and their operations and to accurately reflect an  organization’s operations and use of assets. In addition to the Form 990,  other sources of data have also been used to better understand the sector,  such as Bureau of Labor Statistics employment data, but continued access  to that data has been a problem. In addition, the funds to perform the  analysis generally come from the nonprofit sector, and are not consistently  available.
Administrative and reporting requirements—Practitioners and  researchers alike addressed the difficulty that nonprofit organizations,  particularly smaller entities, have in responding to the administrative and  reporting requirements of their diverse funders. While funders need  accountability, the diverse requirements of different funders make  reporting a time-consuming and resource-intensive task. Experts report  that both government and foundations have increasing expectations that  nonprofits conduct performance measurement, but meeting the  expectations, given the size of grants and the evaluation capabilities of the  staff, can be difficult. One researcher said that practitioners report  performance evaluation as one of the biggest challenges they face, given  their capacity issues.
Fiscal challenges for nonprofits—Nonprofit organizations, particularly  smaller entities, often operate with limited budgets and have limited  capital. As one researcher noted, the logic of the business world is  “upended” with nonprofit organizations. Researchers and practitioners  have pointed out that nonprofit organizations often have inadequate funds  to invest in management infrastructure and that government and private  foundations have not provided them adequate overhead funding to, for  example, pay salaries to attract employees with needed skills or upgrade  systems that would maximize efficiency. Funders—federal, state and local  governments, foundations, and private donors—are willing to pay varying  amounts toward overhead, resulting in nonprofit organizations needing to  sometimes turn to other sources to cover their overhead costs. We believe  this is an area in which more data are needed to fully understand the  implications of reimbursement for overhead charges.
section_title: Concluding Observations
paragraphs: Virtually every American interacts with the nonprofit sector in his or her  daily life through a broad range of concerns and activities such as health  care, education, human services, job training, religion, and cultural  pursuits. In addition, federal, state, and local governments rely on  nonprofit organizations as key partners in implementing programs and  providing services to the public. Given the way the sector is woven into  the basic fabric of our society, it is essential we maintain and cultivate its  inherent strength and vitality and have accurate and reliable data on the  overall size and funding flows to the sector. Keys to a healthy nonprofit  sector include strengthening governance, enhancing capacity, ensuring  financial viability, and improving data quality without overly burdening the  sector with unnecessary or duplicative reporting and administrative  requirements. At the request of the Congress, we are beginning work to  examine these issues further.
Mr. Chairman, this concludes my prepared statement. I would be happy to  respond to any questions you or other Members of the Committee may  have.
section_title: Contacts and Acknowledgments
paragraphs: For further information on this testimony, please contact Stanley  Czerwinski at (202) 512-6806. Contact points for our Offices of  Congressional Relations and Public Affairs may be found on the last page  of this testimony. Individuals making key contributions to this testimony  include David Bobruff, Tom James, Heddi Nieuwsma, Carol Patey, and  Tom Short.
section_title: Appendix I: Key Terms Related to Nonprofit Status
paragraphs: Tax-exempt organization: An entity determined to be exempt from  federal income taxes.
Nonprofit status: A state-law concept, in which approved entities  may be eligible for exemption from sales, property, and state income  taxes.
Section 501(c)(3) organization: An organization that has an exempt  purpose such as serving the poor; advancing religious, educational, and  scientific endeavors; protecting human rights; and addressing various  other social problems.
IRS Form 990: An IRS information return that many tax-exempt  entities, meeting certain requirements, must file annually.
section_title: Appendix II: Types of Programs and Services in the Nonprofit Sector
paragraphs: This is a work of the U.S. government and is not subject to copyright protection in the  United States. It may be reproduced and distributed in its entirety without further  permission from GAO. However, because this work may contain copyrighted images or  other material, permission from the copyright holder may be necessary if you wish to  reproduce this material separately.