Tax Advantaged

If the Girl Scouts don't get you, the YMCA will
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After 17 years on the faculty of Washington State University, Jerry Brong decided to strike out on his own. Back then, the market for personal computers was just heating up. And what better place to set up a computer retail store, Brong figured, than right there in Pullman, with an ever-changing market of 16,000 students?

Too bad for Brong that, at about the same time, executives from Apple Computer Inc. and IBM Corp. also saw all those potential customers in Pullman. Their idea was to sell the students personal computers at "superdiscount" prices, building brand loyalty for decades of computer purchases yet to come. The university was only too happy to cooperate with that corporate strategy, converting a conference room to a Personal Computer Center. And what with the deep discounts from the manufacturer and a minimum of overhead charges, the computers fairly danced off the shelves.

"Our market vanished," recalls Brong, then in his second year of operation. Brong watched two other stores close their doors as he hung on grimly, finally filing for protection from his creditors last spring under Chapter 11 of the federal bankruptcy laws. Indeed, so incensed was Brong about what he believed was unfair competition coming from the tax-exempt university that he took his case all the way to the statehouse in Olympia. And that's when his real troubles began.

"My campaign has not been good for Washington State University's public relations," admits Brong. "This town lives by the university, and if this flap causes a decrease in funding, the Pullman economy gets hurt." One local newspaper went so far as to call Brong "an unconstructive pest," and the university-affiliated customers he did have began avoiding his store. Says Brong with a sad laugh, "My backside's got buckshot all over it now."

Jerry Brong has learned an important, albeit an expensive, lesson in practical politics -- namely, that which is unfair is not necessarily unpopular. The public loves an underdog. But it loves a cheap computer even more.

Today, there are thousands of Jerry Brongs around the country, and they are hopping mad.

Small-town bankers complain that credit unions, formed back in the 1920s by people with common bonds and modest means, have now become a gigantic industry: 55 million members, more than 15,000 offices, $180 billion in assets. They offer credit cards, automatic teller machines, checking accounts, and a full range of loans. What they don't have are taxes. And as the bankers see it, that allows credit unions to pay higher interest to depositors, charge lower fees, and offer fat salaries and cushy perks to their officers.

"They are simply banks in disguise," asserts Edward N. Delaney II, a representative of the Bankers Committee for Tax Equity, in Washington, D.C., a coalition of about 1,000 community banks. Delaney speaks for 1,000 against the interests of about 55 million depositors, which is not the kind of political arithmetic that impresses politicians. Perhaps that is why Delaney's proposal to tax just the largest credit unions -- those with $10 million or more in assets -- never saw the light of day during the tax-reform debate last year.

Health-club proprietors are another aggrieved group who now find themselves squared off against no less a motherhood-and-apple-pie institution than the YMCA. Time was when YMCAs existed to provide a swimming pool for the community and sports programs for the kids. Many still do. But take a look at some of the Ys in wealthy suburbs and downtown financial districts, where Mr. and Ms. Yuppie work out on state-of-the-art fitness gear before taking a dip in the Jacuzzi. And with no property taxes or sales taxes to worry about, they can easily price themselves just a tad beneath the for-profit health club down the street. And do.

In Portland, Ore., Rock Island, Ill., Topeka, Kans., and Pittsburgh, local officials have tried to curb this sort of unfair competition by rescinding the local Y's nonprofit status. But now the Ys have begun to fight back. How many brochures showing smiling kids arm-in-arm around the pool or the camp fire will it take to sidetrack similar inquiries in other cities?

Perhaps the biggest success scored against the nonprofits was in the state of Utah, where the nonprofit Intermountain Health Care chain, the state's largest private employer outside of the utility companies, has lost its automatic tax-exempt status as a result of a decision by the state supreme court. Evidence presented in the case showed that for-profit hospitals in the region were providing more free care to the uninsured than Intermountain, effectively calling into question the hospital's public-service claim.

Nor is Utah the only place where the special treatment of nonprofit hospitals has been challenged. A recent report published in the Harvard Business Review found that, based on a study of 14 major hospital chains, tax-exempt hospitals are no more accessible to the uninsured and the medically indigent than for-profit facilities. What nonprofit hospitals did best, the authors found, was to "maximize the welfare of the physicians" who run them. For-profit hospitals, they concluded, "produce better results for society and require virtually no societal investment to keep them afloat."

If you think taking on the nation's medical establishment is tough, try taking on the animal lovers. Michigan veterinarians did just that when they discovered that nonprofit humane societies were opening fee-for-service clinics around the state. Here was an activity, they argued, that went clearly beyond the care and feeding of stray animals. And as a result of their lower rates and the society's good reputation, these tax-free clinics had began to steal away a respectable share of the routine veterinary trade.

Among those hardes hit was veterinarian Peter Prescott, who made fighting the humane societies something of a full-time campaign as executive director of the state veterinary association. His proposed remedy, presented to the Michigan legislature, would have required the humane societies to set up separate tax-paying corporations for their fee-for-service clinics and other commercial ventures. The idea sounded fair enough to several members of the Michigan House of Representatives when Prescott began shopping his idea around. But an avalanche of mail from Michigan's animal lovers soon hit the capitol, and when it came time to look for a sponsor, there was none to be found.

"Legislators don't want to stick their necks out just to get them chopped off," Prescott concludes. "What's in it for them?" There are, he points out, only 1,200 veterinarians in the whole state; dog and cat owners number in the millions.

And so it goes. At last count, there were more than 900,000 tax-exempt organizations operating in the United States, employing 10% of the American work force and generating an estimated $300 billion in revenues each year. That kind of money doesn't come from spare change dropped in Salvation Army tin cups. And, to hear it from small-business owners, too much of it comes out of their hides. Across the country, nonprofits -- many of them under financial pressure to become more "businesslike" in their management -- have begun peddling everything from packaged vacation tours to prescription drugs, offering services that range from landscaping to catering of weddings. And without some change in government policies, most experts expect the trend will only accelerate.

All this came to something of a head at last summer's White House Conference on Small Business, where delegates voted "unfair competition" their number-three concern, right after liability insurance and mandated benefits. The issue reached a rhetorical crescendo as the delegates stepped up to the microphones to swap horror stories. But their proposed solution, stripped to its basics, urged only that unfair competition "be prohibited." The details were left to others.

The problem, of course, is with the details -- defining precisely what unfair competition is and what government can do about it. For even if elected officials were inclined to begin curbing the entrepreneurial instincts of the nation's nonprofits, writing that inclination into law is no mean feat. The policy that takes aim at tax-exempt veterinary clinics and subsidized computer stores can't be so broad that it threatens Girl Scout cookie sales, the weekly church ham-and-bean supper, or the Rotary Club car wash. And while government can deny tax breaks to certain nonprofit enterprises, it cannot deny them their captive audiences or their breakeven pricing strategy or the "halo effect" that comes with nonprofit status. Any regulation, to be effective, would have to be applied case by case, industry by industry -- a process that would surely be time-consuming and contentious.

Right now, federal law requires only that nonprofit organizations that run for-profit operations pay an "unrelated business income tax." But even Internal Revenue Service officials admit the tax is difficult to administer. One problem is separating the costs and expenses of the profit and nonprofit aspects of a single organization. Another is defining exactly what activites are "unrelated" to the organization's original purpose. As a result, only 28,000 nonprofits bothered to file corporation income-tax forms last year, paying just $153 million to the federal government. "This is not a big area for compliance," admits an IRS spokesperson.

Jerry Brong is beginning to understand why. Responding to intense lobbying by Brong and others, the state legislature passed a so-called unfair-competition law that has been the rallying cry of small-business groups in several states. The Washington initiative calls, among other things, for state colleges and universities to set up committees to review and regulate their retail operations and report their findings back to the statehouse by year's end.

Brong, of course, hopes the measure will bring some relief to his business and some reason to the issue. But he also sees it raising more questions. When colleges allow local residents and staff free access to their gymnasiums, for instance, does that impinge on local health spas? And if a college sells hot dogs at football games, must it now award that contract to an outside vendor? Can universities establish their own day-care centers for staff and students with children, or would they be unduly interfering with commercial centers?

And how would a law prohibiting unfair competition impact the university's computer store? Who will determine the overhead that should be counted against its operations -- the cost of electricity going into that store, or the portion of the dean's salary, or the property tax that might otherwise have been paid on that square footage? And what are the real payroll costs if the store's staff members are university employees covered under the state medical and pension plans?

Like most political controversies, the issue of unfair competition is controversial precisely because it is difficult. If it were wasy, no doubt somebody would have already resolved it. In fact, you might say that, despite its number-three ranking at the White House Conference on Small Business, the chances for prompt action on this issue are not much better than for, say, conference recommendation number four. That's the one calling for a balanced federal budget.

Last updated: Aug 1, 1987




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