In 2008, the John A. Hartford Foundation, along with the rest of the world, suffered through a devastating economic meltdown that we are still feeling to this day, three-and-a-half years later. The Foundation’s assets plummeted by a third, but we were among the lucky ones. Other foundations had to close their doors due to the meltdown and other bad investments, namely the Bernard Madoff scandal.
In order to stay afloat, Foundation staff and Trustees decided they had to take some drastic measures, which ultimately would cause much pain to our grantees in the short term but, hopefully, make them (and us) stronger in the end. While the trustees did “dip into the endowment” and raised grant payments in 2009 and 2010 beyond our standard payout, we felt that we could not weather the storm by dipping further into the endowment, particularly when many of the investments were still valued at distressed prices.
Sometimes an action that is intended to have a positive effect, when put into practice, can have the opposite outcome. An article in the March 25, 2009, New York Times talks about a good example of this—the two-tiered federal excise tax for private foundations. While intended to spur foundations to pay out more in grants by giving an incentive in the form of a lower 1 percent rate on foundation investment income and realized gains, versus the previous 2 percent flat tax rate, it does the opposite.
Without delving into the legal nuts and bolts of the excise tax, suffice it to say that in order for a foundation to continue to qualify for the lower rate year after year, it must annually raise the percentage of assets that it spends for grants and expenses. So far that sounds good, but in the long run, it leads to less money for grants because the foundation, in effect, spends down its endowment.
In order to correct for this “bracket-creep” or ever increasing payout rate, every five years or so a foundation that strives to exist in perpetuity, in accordance with the wishes of its benefactor(s), may find it advantageous to reduce the amount it spends in that particular year. By so doing, it purposely pays the higher 2 percent tax rate but makes meeting the requirements for the 1 percent rate easier in the future.