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One of the country’s most intriguing billionaire philanthropists is sounding the alarm about a highly controversial tax loophole that has advantaged his class of donors over the last decade.
Donor-advised funds are the philanthropic middlemen that house over $100 billion in assets nominally slated for charity — well, eventually. Rich people cut a check to a DAF to avoid paying a capital gains tax today — and then theoretically donate the money stored in the DAF over a long period of time. But critics say that DAFs are effectively a tax scam because the wealthy don’t actually give enough to charity to merit the tax break.
But most of this criticism of DAFs has come from academics and charitable consultants. Not much outrage from the billionaires themselves, which makes sense, since DAFs reward them with a fantastic tax loophole.
That is, until this month, when John Arnold, a Houston-based billionaire who is widely considered one of the most thoughtful philanthropists when it comes to reckoning with the power of the wealthy, sharply criticized DAFs in a way that ricocheted around the world of philanthropy. That’s because Arnold is one of the first billionaires, observers say, to criticize this system.
I spoke earlier this month with Arnold in a rare interview. Our conversation, edited for length and clarity, is below.
So few billionaires and wealthy people are willing to talk about DAFs and ways to reform them. Obviously a lot of people clearly benefit from the status quo. Why did you speak out about this?
I think giving is more effective whenever it is more directly tied to the individual who’s funding the decisions. One of the roles of philanthropy is to go further out on the risk spectrum than what government is willing to do, or even what the private sector is willing to do. But I’ve found that legacy foundations — when they did get managed by professional staff and have the whole board governance structure — that everything gets more bureaucratic and the willingness to take risk really starts to decrease. This is counter to one of the roles of philanthropy.
The second big problem is this idea of giving from the grave. And how do you define the mission, whenever you have to write down in your will, for how this money is to be spent in the future, oftentimes by people that you don’t even know?
I’ve found that it’s very hard to reach that sweet spot on what the mission is. You don’t want to be trying to solve yesterday’s problems in the future. But if you make it too broad, then anything becomes eligible for the foundation.
So is the answer for why you felt compelled to speak out about this just that you were angry with current policy? A lot of people could say this, but they benefit from the status quo.
The philanthropic sector, especially foundations, have, by their nature, very little accountability. One of the benefits is that because they don’t have that strict accountability by outside actors, they’re able to take those types of risks that I talked about earlier.
So the accountability really comes from the public criticism — and they’ve endured a fair amount of public criticism over the past couple of years. And I think it’s important to step back and say, “What parts of the criticism is valid? And what’s more shaky?”
This DAF issue is one of the areas where the criticism is valid. People are getting a tax advantage today by putting money into the DAFs, and they’re not abiding by the spirit of the regulations about how that money is to be put back into society.
Your argument is that DAFs delay charitable giving. Do you think they actually reduce charitable giving over the long term? Because if not, the argument is: “Well, the money’s irrevocable. It’s still going to charity eventually.”
It’s two arguments. One is that I think this generation has a moral imperative to solve this generation’s problems and that putting this money away to be spent at some indeterminate point in the future — by somebody else with some mission statement — it’s just inefficient. And I think it’s just not in the spirit of what giving is supposed to be.
What I’ve seen firsthand is many people who have intent to give away very significant resources, but they delay the actual giving. So they build up the resources either just as a private net wealth or through some type of vehicle like a DAF. And the intent is always in the future. And then they get too close to death. And then the question is, “Okay, now what do I do?”
Whenever you’re trying to give away a lot of money in a short period of time, you either end up creating a legacy foundation that has the problems of legacy foundations, or you have to write large checks — and those large checks end up going to organizations that can accept a large check.
And then the three types who generally do accept these big checks are college fund institutions, universities, and hospitals, all that frequently have a capital campaigns to build new facilities. And so the money ends up going to those sectors that, I would argue, tend to be well-funded already, instead of going towards the operating expenses of smaller organizations that are doing social services.
So you think that DAFs either A) Delay donations, or B) Lead donors to give to institutions that don’t really need the money? Which means that even if the actual top-line money out the door is the same, you feel it reshapes the places and the timing.
Exactly.
All these DAF sponsors, or lots of them, have dormant fund policies, at least in theory, which require a minimum amount to be disbursed in a certain time period. Fidelity, or here in Silicon Valley the Silicon Valley Community Foundation, they have these policies. Do you think of those as just totally ineffective?
I do. I don’t know a lot about the specifics of them. From what I’ve understood, you have to make a token donation every few years.
Yes.
And so it’s nowhere near the 5 percent. You can go an entire calendar year, or years, without giving away any money and that’s fine.
There has to be some giving involved with this so that it’s not just an investment fund.
But you don’t see possible sufficient regulation of DAFs from within, for instance? What if DAFs made their policies better or made their dormant fund policies better?
It’s hard to see that since the sponsors generally have an incentive to build assets. Their incentives are counter to give more, give sooner.
The main criticism of DAFs centers on transparency. We don’t really know how many of these DAFs are giving and whether it’s enough. Are you in favor of a policy change that each DAF account should have to tell regulators how much it spends in a given year?
I believe that each DAF account should meet that minimum 5 percent spend. How do you enforce that? There’s probably a couple of ways. You could just put the onus on the sponsor of the DAF to make sure that each of those accounts spends its 5 percent, or else that money would be pulled out of the account, and the sponsor can create some basket of nonprofits that that money would automatically go to.
That would be the argument of, “The DAFs can fix this themselves.”
Right.
On the idea of a minimum payout requirement, which you’re advocating to be 5 percent, I’m sure you’ve heard this counterargument. It’s that you would see these DAF accounts spend 5 percent — and only 5 percent — a year. They argue that the payout requirement would be a ceiling rather than a floor. Why do you think that’s wrong?
Whenever it is a board that is making the determination, especially a legacy foundation board, I think there’s a lot of deference given to ensuring that that foundation’s assets and influence do not shrink over time.
The idea is that this important foundation has to remain important forever.
Yes. And that the board shouldn’t be decreasing the importance of that foundation over time.
But I think that would actually be the right thing, that dead people’s influence should decrease as time passes. And there’s lots of examples where that influence has increased over time.
I think it would be more efficient if those big legacy foundations, that they brought forward their giving and let the next generation of givers be more influential in the next generation.
How are you thinking about the spend rate of your own DAF? Have any of the topics we’ve been talking about shaped your approach to the ways in which you spend money and the speed?
So right now we are set up to wind up our philanthropic activities, or our giving, five years after our deaths.
We don’t want any of our entities to exist after five years of our death. Now, if we were to die tomorrow, that would necessitate a much higher spend rate over the next five years than what we’ve been giving. And so our intent is actually to be a spend-down foundation even as we’re living.
What do you make of the fact that there’s this new conversation around billionaire power in politics right now? I know you were saying before that you feel like some of the criticism of philanthropy is valid, but some of it’s not fair. What do you make of this new conversation around this issue? Do you think it’s fair so far, or are you nervous about it going overboard?
Some of the criticisms are fair. I think some of the criticisms are overboard.
For instance, there was a blow-up about how the people who had pledged money to the Notre Dame rebuild had only given a small percentage of those pledges to date. When, in reality, that was all the state had asked for, because it would be normal to fund it as the money’s needed. It would be more unusual if they put all that money into an account on day one.
It’s just not standard practice on anything where the need for the money is going to exist over a very long period. So why fund it into an account on day one? The ask is generally: when the money is called for, you fund it. And somehow people are criticizing some of the wealthy donors because they didn’t put it all into an account on day one. That type of criticism seems ridiculous to me.
I’m curious how you’re thinking about 2020. Obviously you know the broader issues around the wealthy are going to be front and center, at least in the Democratic primary. I’m curious if there are any candidates in the primary at least that you see as interesting or impressive?
I’m still trying to make up my mind. I have not chosen a favorite yet.
I assume, though, that folks who are the furthest left — Warren and Sanders, who are the most anti-billionaire, anti-wealthy — I’m assuming you don’t have a ton of comfort with that?
I’m still trying to come up with my conclusions on some of this stuff. But there is broad discontent among large pockets of the population, and I think we need to think about to what extent has public policy created that. And what’s the right role of government and where can government provide those solutions? What’s the role of government in that? And I think those debates are healthy.
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