The foundation construct is terrible public policy — we need a rethink
Bill Young explains why only radical changes will work
I recently wrote an article for Policy Options, where I put forward a bold idea for how the government could make foundations invest in impact. In 10 years, any assets held in traditional investments would become taxable, leading to an eruption of impact investing activities throughout Canada.
Soon afterwards, I was very glad to see a response published by Hilary Pearson, until very recently the president of Philanthropic Foundations Canada, who argued foundations should be freed up to invest effectively, but not forced to.
The foundation world should be openly discussing public policy issues like these — so I relish the debate!
In that spirit, I wanted to write a brief response to her article, which I believe misses a few critical points of my argument. These points explain why a radical idea like mine is so necessary. A subtler approach will not, in my view, provide the right solution.
The foundation construct is flawed
First and foremost, Hilary fails to address my core argument from which everything else cascades: that the foundation construct is awful public policy.
Foundations are given significant tax breaks in return for deploying just 3.5% of their assets to societal benefit each year. Surely this is an unacceptable deal for society and taxpayers?
For Hilary’s recommendations to be persuasive, she must explain why this current construct is not seriously flawed. If I’m right, then her solution — whereby foundations regulate themselves and move gradually towards more impact investments — just isn’t good enough. We cannot expect wholesale change out of foundations’ good will, or without a catalytic event.
At best, in the same 10-year time frame as my solution, Hilary’s proposal might see a number of foundations reaching a 10% impact investment target (currently in vogue as a good number to meet). Rest assured, though, that the overall average would still be less than 10% of the foundation sector’s investable assets, leaving more than $50 billion that they hold tax-free in traditional investments. That’s still a horrible deal in my eyes!
What government should do
In her article, Hilary makes three specific criticisms, which stem from our different views about where regulations are appropriate and effective.
1) Regulation is often “not the best tool to ensure that good is done”
Yikes! We could talk until the cows come home about the merits of regulation — there is no easy right or wrong answer here.
The thing is, however, the government already regulates the “good” being done. On the disbursement side, for example, a foundation must donate 3.5% of their assets, and it must be to registered charities — not to nonprofits that aren’t charities.
“Given a foundation’s mission, is it so crazy to suggest they should take on this new responsibility?”
Why not regulate the investment side as well? Yes, it means agreeing on what qualifies as acceptable and unacceptable investments from an impact perspective. That’s not simple, which is why I included a 10-year timeline, ensuring plenty of time for foundation input into the regulations before they come into effect.
Of course foundations would still have a “fiduciary duty” when they do their due diligence, as the government requires. Only now, part of their due diligence would be whether it meets a social purpose. Given a foundation’s mission, is it so crazy to suggest they should take on this new responsibility?
2) “Governments are referees but not coaches when it comes to investments”
Hilary argues here that we’re wrongly trying to turn governments into investment coaches, when they should just be referees.
With my proposed solution, however, foundations would not be regulated to invest in any particular security or fund or sector. They would still have freedom to make whatever choice they want, only they will be tax advantaged if they invest in something with a positive social or environmental impact — much in the same way that they are tax advantaged when disbursing over 3.5% to charities.
“It’s misguided to expect that government and investors operate in separate worlds”
The government, therefore, is a referee — not a coach — in this situation. It is setting out the rules of the game, within which foundations are free to move however they like.
There are plenty of precedents on how governments use tax incentives to encourage certain types of investments over others, like how the referee and rules influence the way a game is played. Governments do often try to exercise influence over investor choices — take, for example, US federal tax incentives for investments in Opportunity Zones — and it’s misguided to expect that government and investors operate in separate worlds.
3) Specialized asset managers are better-placed to invest diligently in impact investments
Here’s where the coach comes in! As I mentioned in my original article, with my proposal I would expect “a robust network of intermediaries would emerge — like traditional investment managers — to guide foundations in implementing their strategies at a reasonable cost”.
I completely agree that we should never expect foundations to have the expertise to choose their impact investments by themselves, just as they rarely choose their traditional investments. Instead, they would be working with impact investment intermediaries to find appropriate funds to invest in. An example would be New Market Funds: an affordable housing fund that a number of foundations have invested in. (I should also point out that I use infrastructure as an illustrative example in my argument — just one area of impact investments we might expect foundations to pursue.)
It would become far easier for foundations to invest in impact. As Hilary helpfully points out, there is already a wide array of impact investing opportunities managed by specialized asset managers. Just imagine how many more funds would be created if an additional $60 billion of foundation money in Canada was freed up towards impact investments.
Philanthropy in Canada
All that being said, there is much to applaud in Hilary’s article. I’m glad to see she agrees with the need to direct more foundation money towards impact investments, and I wholeheartedly support her suggestions on modernizing the Income Tax Act.
I also want to take this opportunity to thank Hilary for her invaluable work as CEO of Philanthropic Foundations Canada, following her recent departure. She has played a vital role in Canadian philanthropy over more than 17 years, and I, like many, are extremely grateful for everything she has achieved in her role.
