Russ Roberts

Pallotta on Charity and the Culture of the Non-Profit Sector

EconTalk Episode with Dan Pallotta
Hosted by Russ Roberts
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Dan Pallotta, Chief Humanity Officer of Advertising for Humanity and author of Uncharitable talks with EconTalk host Russ Roberts about the ideas in his book. Pallotta argues that charities are deeply handicapped by their culture and how we view them. The use of overhead as a measure of effectiveness makes it difficult for charities to attract the best talent, advertise, and invest for the future. Pallotta advocates a new culture for non-profits that takes the best aspects of the for-profit sector to enhance the mission and effectiveness of charities.

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0:33Intro. [Recording date: May 23, 2013.] Russ: Our topic for today is your book, Uncharitable. It's a rather extraordinary book which I found extremely interesting and provocative. If you are involved in a charity out there listening, or if you give to a charity, which I hope is almost all of you, you should read this book or watch Dan's Technology, Entertainment, Design (TED) talk or listen to the rest of this podcast. There's a lot to think about. You argue that our cultural attitudes towards charity have made charitable organizations less effective. What's wrong with how we think about charities? Guest: Well, we have these two rule books. We have one for the non-profit sector and one for the for-profit sector. And in the name of an ethic, this separate rule book really discriminates against the sector in at least 5 different areas that I described in the book: compensation, the ability to advertise and market on the scale that the for-profit sector does, the ability to take the kinds of risks the for-profit sector takes, the amount of time the for-profit sector has to demonstrate the value of an investment, and last but not least a capital market itself. So we have this deprivation-, all-volunteer-, all-donated-goods-mindset about the charitable sector, and it may have worked when charity was about neighbor-to-neighbor assistance, but it doesn't work when these organizations are attempting to solve large-scale global logistical problems. Russ: Let's take a couple of the examples you talk about in the book. Let's start with compensation. So, it does sound good, as you just mentioned, to get things donated: We're a charity, we didn't pay for any of this, this is all donated; a lot of our workers are volunteers and our staff is paid a very small amount, because that way more of your money goes to the cause. And those two issues--compensation and then overhead, which you discuss a lot in the book--those sound great, don't they? We don't overpay our employees and we keep our overhead low that way so that more money goes to the cause that you all care about. What's wrong with those arguments? Guest: It does sound good, doesn't it? More of your money goes to the cause. Well, there are a number of different problems with that. First of all, this focus on costs and this focus on overhead eliminates any conversation about impact. So, we're not having a conversation about how effective the organization actually is at solving problems. So, who cares if the overhead is low if no problem is getting solved? And really, who cares if the overhead is high if the problem is getting solved, because ultimately we want the problem to get solved? So the overhead question has a number of flaws. A few of the easy ones to talk about and describe are, first, it operates on a mistaken theory of waste. So, a charity tells you $.90 of your donation goes to the cause and you think: Well, that's great, now I know that they don't waste any money. But you don't know that at all. How do you know they are not wasting the $.90 that's being spent on the cause? That's where all the money goes; that's where the largest opportunity for waste is. Related to that, it tells you nothing about the quality of services. So, that soup kitchen can tell you $.90 of every donation goes to the cause and you'll never learn that the soup is rancid. Because you never asked about the quality of the soup. Next, the percentage of your donation that goes to the cause depends entirely on how the charity defines the cause. So, the more broadly they define the cause, the higher the percentage they can tell you is going to the cause. It actually operates on a false theory of transparency as well, because unless you know the underlying accounting and definitions of the cause, there is no transparency in that simple articulation of an overhead percentage. Worse, this demand the charities keep overhead below prevents them from spending money on the overhead things they have to spend on in order to grow. And that's how we institutionalize the miniaturization of these organizations. We're dealing with massive social problems, so the last thing we want is miniature organizations. On the simple question of fundraising, a donor will say: Well, I don't want them to spend any money on fundraising; I want as much as possible to go to the cause. Basically you are saying: I want to be the only donor. Because I don't want you to spend any money going out to find other donors. I want the full weight of the organization to rest on my shoulders and the other donors that you now have. Well, if a donor thinks about that, that's not what they want at all. So, those are just a few of the deep flaws with the overhead ratio and using it as a proxy for good. Russ: Now, talk about compensation, because I think that's a great example. I was listening to a high-ranking exec in a charity and he was bragging about the fact--this was after I'd read your book, and it was a couple of weeks ago--that when they bring in more money, they have some revenue source, when they bring that in, he said: Not a penny goes to my salary. It all goes toward the cause. And I thought, first: Yeah, that's great. And then my second thought was, having read your book: Maybe that's not the best way. So, explain why not. Guest: Well, we want to be able to recruit the best talent in the world to solve the world's largest social problem. And I think it's ridiculously naive for us to believe that economic incentive doesn't play a role in that. It's ridiculous to believe that people will do everything out of the goodness of their hearts. People will do a lot out of the goodness of their hearts, but they won't take a half-million dollar salary cut. Russ: Or they are less likely to. Guest: Now there are some people in the sector who say: Look, I work for $160,000 a year and I could be making more money in the for-profit sector, so everybody else should. I think it's arrogant to impose your morality and your ethic on everyone else. If that works for you and you are happy, great. Wonderful. Good for you. But there may be somebody who is extremely valuable who could make a huge difference who wants three times that money, and you should not have the unilateral right to say that charities shouldn't be able to hire that person. It should all be based on--see, here's another case where we look just at cost. What is that person costing us? And we don't look at the benefit side of the equation. No first-year business school student would survive past the first semester if they didn't show the ability and the inclination to do a cost-benefit analysis. So the question is not what does the person cost. The question is: What value is the person producing for that cost? So, you could be getting someone--let's say we were looking at the simple issue of fundraising. You could be getting someone who is only paid $80,000 and the organization says, we don't pay any of our fundraisers any more than $80,000; but that person is only capable of raising $160,000 a year or two times their salary. Versus another person who might cost $300,000 but is capable of raising $3 million a year. Now which person is cheaper? But we don't ever look at it in that way. We don't ever look at it rationally. Even economists tend to--we have this religious, emotional perspective on these things instead of a rational one. And I think the people who suffer in this world are desperate for us to take a rational look at these things.
9:56Russ: Now, one of the virtues of paying relatively small amount for talent and leadership roles in charities is that it's going to draw people in, who are going to apply for those jobs, who are devoted to the cause. Of course it also draws people who don't have very good alternatives. That's the other side. That's your point. But the flip side is that it does tend to attract people who are willing to sacrifice money in return for their devotion for this particular cause. If we offered competitive salaries, maybe people are making three times as much as a leader in a charitable organization, how do we monitor devotion? How do we monitor excellence? How do we monitor whether people are effective--which is the point you continually and correctly raise? Guest: It's such an arrogant point of view for some people in our sector to say, well, we don't want to introduce money into the picture because that will bring in people who don't have any passion for the cause, and only those of us who don't care about money are really passionate about the cause. Really. You mean the people who work at Apple aren't passionate about the iPhone and the iPad and beating the pants off of Android. Really. You mean the people at Google aren't passionate about an open system and spreading Android? A heart surgeon who makes a million and a half dollars a year isn't passionate about heart surgery and doesn't have patients coming to him or her based on how effective they are at performing heart surgery. It's absolutely sophomoric. People will say to me: If somebody wants to make a lot of money, it's a sign that they don't really belong in the non-profit sector. But excuse me, it's those people that make a lot of money that make up the rolls of your major gift roster and that make your organization possible. So how on earth can you say that they don't have any heart because they have an interest in money? You are looking at human beings as half a person. That they don't have any interest in--let's not talk about the abstraction of money--that they don't have any interest in sending their kids perhaps to a private school, that they don't have any interest in taking the best possible care of their parents in their old age. That they don't have any interest in being able to travel with their children around the world, that they don't have any interest in being able to make large charitable contributions. So, here is another case where we have kindergarten-level thinking about these things. Russ: Well, I really like your point because in the aftermath of a natural disaster, when people decry high prices for fundamental things like water and milk and basics, I always make the argument that if you let the price rise, you'll draw people who both want to make money--that's true, that's going to be one of the reasons they'll load up their truck with plywood after a hurricane or a tornado and travel 400 miles; but the other reason is because they are going to help people. Why would you assume they only care about the money? The beauty of the money is you get both, the full range of human desires and facets. And what you are pointing out is that you have said, culturally, oh no, this is only for people who don't care about money. As if such people actually exist. They don't of course. It's ridiculous. Guest: Right. If you tell me that you don't care about money, I say to a hypothetical person, and that people shouldn't want to make money in the charitable sector, then why would I want to pay somebody three times the amount of money you're making do you get all bent out of shape? You told me you don't care about money. Russ: Now, this seems pretty logical to me, and I think even to non-economists when they hear it. What's interesting to me, and you chronicle this very nicely in the book, is that you'd think people would go, that's a good point, you're right. They don't though. Historically they haven't. What they do is when a charity is found to be paying a large amount of money to an executive, there's a scandal. And you give example after example of media coverage and how damaging it is. Guest: Right. Salaries that would be utterly unremarkable, $6-$700,000 dollars in the for-profit sector, are scandalous in the non-profit sector. Meanwhile, that the head football coaches at the top 20 universities in the United States each made at least $2.6 million dollars last year and they are all non-profit universities. But God forbid you should pay the head of Save the Children $2.6 million--call in the Attorney General. Russ: There are people who are offended by the college coach salary. But I take your point. Guest: Well, then let's move on to Jon Stewart[?] who makes $16 million a year or David Letterman who makes $28 million a year or Judge Judy who makes $45 million a year--makes the football salaries look absolutely poverty scale in comparison.
15:15Russ: Tell us a little bit, as background to this conversation, what you did at Pallotta Teamworks, why it was controversial, and why it was successful; what you actually accomplished. Because it's an incredible story. Guest: Yeah. Well, we created the AIDS Rides and the Breast Cancer 3-Days which really led to the creation of-- Russ: Explain what those are. Guest: Yeah. They were very different types of charitable events. They were not a 5-k Saturday morning walk-a-thon or a 10-mile bike ride around town. These were really epic journeys that asked people to draw deeply from the well of their potential. So, the AIDS Ride for example in California was a 7-day ride, 600 miles from San Francisco to Los Angeles, or the Montana Ride across the Continental divide. The Breast Cancer 3-Days were 60-mile long walks that lasted three days; and you had to go the whole 60 miles, you had to go the whole 3 days, you had to sleep in a tent overnight; and you had to raise a minimum amount of four figures in order to do it. And that had never been done on these 'thon events before--they always welcomed people with open arms no matter how much or how little they raised. So it was the combination of the multi-day, epic, grueling nature of these things, with the 4-figure minimum fundraising requirement, with mass marketing--full page ads in the New York Times, 60-second radio spots in the morning and drive time in the evening alongside the ads for cellular service, that the combination of those three things created something new and created something very successful. And we had 182,000 people ride or walk in one of those events over the course of 9 years. They raised a total of $582 million dollars-- Russ: $582 million dollars? That's so mind-boggling. That must have been extraordinary. Guest: It's a lot of money. And 3 million Americans donated to the event. These things have been distorted over time; now it's sort of called the Athletic Event industry. It was never about athletes. In fact, we never marketed to athletes. We were looking for the 69-year-old woman who had lost her son to AIDS and needed a huge vehicle for the expression of all that anger and grief. We were looking for average people who wanted to do something extraordinary, and they came in droves. And they were the most beautiful examples of civic engagement and human compassion that you've ever seen in your life. Because every one of the participants had a story like that. So it was about much more than the money; and the money was huge. And this was 1993, when we started this. There was no lexicon for social enterprise, social entrepreneurship, doing well and doing good. There was no social enterprise program at Harvard, no Stanford Social Innovation Review, none of this conversation was happening. The lexicon was: You are good if you sacrifice and you are a parasite if you don't and you try to make any money doing good. And so, I think it was the combination of an entrepreneur, a young entrepreneur--me; I was 32 years old at the time I started it, and I had a very public presence. I would speak at all of the events and at the opening ceremonies, at the closing ceremonies, the company had my name on it--in the tradition of the Walt Disney Company. My grandfather had a construction company called Pallotta and Sons Development, and I believe if you believe in something then you stake your reputation on it and put your name behind it, in the way that the for-profit sector often does. I think it was the combination of that, the lack of any kind of a support mechanism, academic or otherwise, to argue against things like overhead. And the fact that we were doing things in a very business-like way, that we were buying full-page ads in the NY Times, that we were paying our executives 6-figure salaries; and the fact that we were so successful so quickly--all of those things created a story that the media could not resist. And so we got labeled as controversial for having an average overhead on these events of 40% on the Breast Cancer 3-Days. Well, bear in mind, we were feeding people, you know, 9 meals over the course of three days; we were putting up 4000 sleeping tents, mobile catering, mobile showering, mobile medical units, sewage systems that had to be moved every day--I mean, this massive military-like infrastructure. The fact that we were able to do it for $.40 on the dollar was remarkable. Picture any kind of a vacation industry that had to show a 60% margin on something like that, right? Russ: Yeah. So, the $582 million that you raised, was that net of those costs or before those costs? Guest: That was gross. Our net over the course of that time was $305 million. We were a for-profit company--that was part of the controversy as well. We simply charged a fixed production fee for each event. We didn't do any commission-based fundraising. And 100% of the money went to the charities, and the charities then reimbursed us on a dollar-for-dollar basis for all of our expenses because we were administering all of the expenses for the event. And then they paid us our fee--a hindsight calculation puts our fees at 4.01% of the gross. For conceiving the events, producing the events, managing all the employees, administering all the expenses, taking risk--in many cases with our own capital--to launch the events. 4.01% fee--it was close to what the credit card companies were getting for just processing the donations without taking any of that risk. The interesting thing, Russ, is that the media was crucifying us and the media was making more money on each event than we were. We were basically a business development arm for the media, because each of our events had like a $4-$500,000 dollar paid media budget. So we get paid, say, $370,000 to produce an event which had a $500,000 media budget. So, here, NY Times, here's $75,000 for you for your full page ad; here, Clear Channel, here's $100,000 for you for the Subway ads that we're going to run. So the tragic irony abounded. Russ: Well, the tragedy got stronger, because the organizations that you benefited with that money, after the controversy in the media, my understanding is that they said, Well, we'll do it ourselves. Guest: Yeah, exactly. Russ: How'd they do? Guest: They didn't do well. The San Francisco AIDS Foundation and the Los Angeles Gay and Lesbian Center decided, after we had 50% overhead on our California AIDS Ride in the year, I think it was, 2000 or 2001, which was higher than our overhead had been in previous years for a number of one-off factors, reasons, was that they said, Well, we're going to go do it on our own, and lower this overhead from 50%. When you do an apples-to-apples comparison--I have it in the book and I don't have that in front of me--but their overhead went up to something like 65%, and their net income went down from $6 million with us to I think about $1.5 million on their own. So a $4.5 million dollar loss in one year of unrestricted money for AIDS services. And that continued the next year as well. The Δ [delta, meaning change] over the course of several years was pretty huge. I think now, maybe, whatever it is, 10 years into it, they might be up to the level that we were at in 2001. Now, when they left, Avon decided, well, the Pallotta team or its contracts must not be enforceable--the contracts that say we own the event, you won't produce it without us, so we are going to test those contracts and we are going to go do the Breast Cancer 3-Days on our own. Well, what happened there was truly dramatic in the worst possible way. Their net income went from $70.9 million with us in 2002 down to $10 million in 2003. So a $60 million dollar loss of unrestricted income for breast cancer research in one year. And their overhead went up. And I don't know that they've ever recovered those numbers. I know for the next two or three years they didn't come close to recovering the numbers that we had in 2002. Russ: It's an incredible story.
24:58Russ: Now, let's move to some of the other issues you raised that you talked about at the beginning of the podcast. Let's talk about advertising. Right now, charities don't advertise very much--for reasons you've talked about. What should they be doing? Guest: They should be building market demand for their philanthropy. This is something that unfortunately the public doesn't understand, because it often gets explained in very complicated ways. But the basic premise is: Look, we have to let these organizations spend more money on fundraising so that they can recruit more donors and so that they can raise more money and have more money to implement their programs. So when I say 'do more advertising,' I mean build more demand. And that could be in the form of television advertising or newspaper advertising or digital advertising. It could also be in the form of hiring more major gift officers. Doing more direct mail. Putting more money into traditional and new forms of fundraising to bring in more donations. Charitable giving remains stuck at about 2% of Gross Domestic Product (GDP) ever since we started measuring it in the United States in the 1970s. And that's a really important number because it tells us in four decades the non-profit sector hasn't taken any market share away from the for-profit sector. Well, if you think about it, if you don't let these organizations spend money building market share, how are they going to build more market share? That 2% translates into about $300 billion dollars annually. But most of that money goes to hospitals and higher education and religious institutions. Only 15% of it goes to health and human services charities, so that's about $45-$50 billion a year. Now that's just not nearly enough to solve problems like homelessness and violence against women, and cure cancer and prevent multiple sclerosis, prevent suicide, and all of the different things that that money is supposed to do. So it's obvious on the face of it that we need more money. Well, how do we get more money? Organizations have to raise more money. How do they do that? Make an investment in it. So, from a perspective of scale, that's what has to happen. If we could move charitable giving to 3%, or 4%, of GDP and have that money go disproportionately to health and human services charities, because those are the ones we encourage to invest in their growth, you know, you are talking about a tripling, a quadrupling, a quintupling of the size of that sector. Well, now you are kind of talking about the scale it would take to solve these problems. Bottom line, I tell people is, argue with me till you are blue in the face; the basic point is this: If you don't want to see things change, if you want to see these problems stick around for a long time, we have a really great system for doing that. Russ: Yeah, the status quo. Do people argue with you a lot? Guest: I have to say that the response inside the sector to these arguments has been overwhelmingly positive, enthusiastic, passionate--like, people are jumping up and down saying this is what I've always thought; I'm glad somebody finally said it; what do we do about it. Russ: How do we get there from here? Guest: And then we have, you have 7% of people who like to harp on the executive compensation thing, you know--like you have some percentage of donors who are just never going to give because they are cheap and they make up all kinds of reasons, like charities are wasteful and this and that. Robert Kennedy saying: 25% of the people are against everything all of the time. So, I'm doing a little better than that. Russ: Congratulations.
29:04Russ: Now, I love your passion and I love your point about social problems and we need to make these organizations get bigger. One of the challenges they face, which is independent of the issues that you raise is that the Federal government spends a lot of money, and state and local governments spend a lot of money on these causes. Which makes it harder for private charities to start in these areas, to thrive in these areas. Just to take an example from this week, it's very interesting--terrible tragedy in Oklahoma from the tornado. It just happened a few days ago. An incredible gesture of kindness, Kevin Durant, Oklahoma City Thunder, the basketball team, donated a million dollars. Now, I don't know what he gave it to; that's a lot of money. I don't care how much he makes--a million dollars is a lot of money to give away. So, I don't know who he gave it to or what effectiveness it will have. But what's striking when I thought about it is one of the things that deters people, that stops people from giving, is that that's going to be declared a Federal disaster area; there's going to be a huge amount of Federal money, and some state money, but mostly Federal that's going to go there. So, I'm going to be contributing to Oklahoma through my taxes; and my incentive to do that through private organizations is reduced. Now, private organizations can still raise money, if they go work on aspects of the problem that the Federal government doesn't touch; they can get money if they do it better than the Federal government does, than the Federal activities. That's certainly true. But do you agree that one of the handicaps for the growth in the charitable sector is the involvement of government in these areas? Guest: I do. I absolutely think that government crowds out charitable giving, not only because of your sentiment about it but because you just have less money to give to charity. So, you have about $300 billion a year coming in from contributions; I think you have another $300-$400 billion a year in fee-for-services; and then you've got another $3, $4, $500 billion coming from the government. So it's really like $1.1, $1.2 trillion. But that government money comes with so many strings attached that it really contaminates it and hampers its ability to do effective things. For one thing, you've got government officials from some central place telling the organizations that work on the ground how they want them to spend the money, instead of the organization that works on the ground getting to decide for themselves. Then you've got the Federal government or state government saying we will only allow you to use, say, 11% of this for overhead. Well, what if the organization's overhead is actually 18%? So, the government is not paying for 7% of it. So the organization has to go find that money from somewhere else. It has to steal it from other programs. Now, if the government money is disproportionately large, then you are talking about a real underinvestment in administration and organizational strength. I think that's why you see, in Europe, there's so much government social service that you see much lower levels of charitable giving. Russ: I don't think it's because they are not as nice as we are. It's possible, but I don't think that is the reason. Guest: Yeah. Their assumption is, well, government takes care of all of that. We could be getting to a place where we are not far from that here in the United States. It will be interesting to see what the Affordable Care Act does in terms of people feeling that they need to give to free community medical clinics and things like that. I think that will probably take a decade or so to work it's way out. But the real issue I think is the government dictating how all that money gets spent, so you don't have individual ingenuity, small organization innovation coming to bear on these problems. You have big bureaucratic central direction. Russ: Well, I interviewed Paul Tough, who is the author of How Children Succeed. The book is a very interesting look at the challenge of childhood and the grit, determination, self-control, achievement. And basically he says most of our efforts to do that through the government have failed. They don't have the right levers; they don't have the right tools. He gives the example in this book of the Harlem Children's Zone, which is this incredible, holistic approach to helping children. It's not just, oh, we're going to make a better school; we're not just going to have a good nutrition program; we're not going to just give some help to single parents who are struggling with time and other issues. We're going to do it all. And that organization has grown and grown and grown. And in the podcast, in the interview, and in his book, Paul complains about the fact that the head of the Harlem Children's Zone has to spend a lot of time fundraising. And wouldn't it be better if they just had a lot of money from the government? My attitude, my answer to him, is: That's one of the reasons he's successful--he has to convince people he's spending their money well. And that's what makes that program work. And we need more of that. We need the government to get out of the way, to let those entrepreneurs, like yourself, create new solutions to these problems that are very difficult to solve. Guest: We have a fundamentally broken marketplace. In the cellphone business, we have a very healthy marketplace because the information is highly accurate. When I buy an iPhone, I know immediately the quality of that device as compared to a Samsung phone, for example. Not so with charity. When I give a donation, when I'm considering giving a donation to charity, I'm looking at overhead ratios--because that's what I've been taught. So I give to the charity with the lower overhead. Then the example of the soup kitchens--what if that means you are giving to the soup kitchen with the rancid soup? In the case of government grant, you have all of these different organizations fighting for government money, not on the basis of the impactfulness of the programs but on the basis again of overhead ratios. It's like using the fuel gauge to figure out how fast you are going. I mean, it could not be more broken. So if we wonder why we are not creating social change: we are not incentivizing it. The only thing we are incentivizing is low spending on overhead. No wonder problems are not getting solved.
36:00Russ: So, I want to come back to a question I asked you a few minutes ago. You went off on a different part of the question. So, I'm considering giving to a charity. I'm thoughtful; I'm not going to just look at the overhead ratio. I'm not going to look at its rating based on that. I want to know if it's solving the problems. And one of the challenges here is that in the for-profit world we have a way to measure whether the organization is achieving its goal--which is profit, the bottom line. Some charities have some revenue sources. But in general the more interesting ones don't. They're not selling anything. They're selling something--excuse me--but they are not collecting money for what they sell. They are trying to achieve something. And they don't have very good measures. They don't have any, often, of how they are achieving it. So how is the donor, or the board member, or the head of the charity--how do I find out whether I am doing a good job? Guest: Two things. We need an information infrastructure in the United States for this, and I've written about the need for what I call an iTunes for charity that has narrative and financial and impact information that's user-friendly on every single organization in the country, that's updated regularly, that's online, and that's objectively gathered. We need an infrastructure like that. And it isn't going to happen for $2, $3 million. It's going to be expensive to build but relatively cheap compared to the amount of money we give to charity. In the absence of that, what can the average person do? They should consider themselves a philanthropist. The institutional funders and the affluent have co-opted that term, so that when you talk about philanthropy you think you are talking about Bill Gates or the Ford Foundation and not the nurse who gives $75 out of her paycheck every month. But she's a philanthropist as well. And she should be--yes, when a disaster like Oklahoma happens, you don't have time to do a lot of research; you want to give $50 to the Red Cross, okay. But you should look, in the context of your whole life, at your philanthropic giving and ask yourself: What are the causes I care about deeply? What impact do I want to have on them and what organizations could help me have that impact? And go do some research, in the same way you do research before you cast a vote for President or in the same way as you do research before you buy a new washer-dryer. You have a right to go to the Pine Street Inn in Boston and say, I'd like to meet with your executive director. Or, I'd like to meet with your development director and get a tour of your facilities and find out how you are trying to end homelessness in Boston. People have to take some personal responsibility for their giving. They have to get off of this addiction to simplicity. Because ultimately the enemy isn't just the overhead ratio. It is our addiction to simplicity. And we run the risk, if we don't make that distinction, of trading one simplistic measure for another. And now you'll have charity watchdogs saying: We give them 3 stars on effectiveness. Well, how did you measure that? Well, we looked at their website to see what they say about effectiveness. Russ: We looked at their video to see if I teared up when I watched the video. Guest: Right. Russ: No, but I think you're right. I think we need--it would be great, it would be an entrepreneurial opportunity for somebody to create this organization that monitors charitable activity and gives real ratings based on not just what tugs on your heartstrings or overhead or other things, but whether they are innovative, whether they are trying to effectively solve problems they are trying to solve. In the short run, before that organization comes into being, I would argue--one of the lessons you are talking about is you tend to give locally. Because you know something about the organization; you know something about the people who run it, something about the quality. There are challenges if you want to give to a large national organization--it's very difficult to get that information right now. Guest: Yeah, absolutely. If you want to give to, say, Alzheimer's research and you are not a scientist. What we have right now are the watchdog agencies, the Better Business Bureau, Charity Navigator, Charity Watch. They have tiny budgets. The first two have a little over $1 million a year each; Charity Watch has like a $500,000 budget. People think they are these huge organizations; they are tiny. Between the three of them they have 30 employees. They don't measure effectiveness. And that's what we have in America for telling donors what's happening with $300 billion in contributions every year.
40:56Russ: So it seems to me, one of the ways to move in the direction you are talking about is to go through the boards. So, most charities--it's a phenomenon I've noticed in my limited experience with these issues. I've been on the board of a few organizations. They have become, I would call it, more businesslike. Some of the things about that are good and some are not so good. But basically, boards of directors of charities, which used to be something of a rubber stamp, have in recent years tried to be more aggressive. They've tried to bring some sort of measurement to what the charity is doing. Again, I don't think that's always--measurement is better than no measurement as long as you can measure something valuable. If you start measuring things because you have to measure something, I think often people measure the wrong things and then incentivize the wrong things. But in theory, the people who can play the role of legitimate, real watchdog are the people on the boards who have some effectiveness, who have some experience with investment and advertisement, the things you care about. I think the challenge is that those people have the cultural mindset that you are fighting and are very uncomfortable bringing their entire business quiver to the archery game when it's non-profit. Guest: They do. They very much do. And organizations have a responsibility to train board members from the get-go and let them know what it is they really want from them and let them know what the culture is and what the goals are and how it is that they are going to get there. It's not--this idea that we want charities to act more like business is disingenuous and cruel. Because we're not for a moment ready for charities to use the big-league freedoms we give to business. A lot of people will dumb down my argument and say he wants charities to act more like business. That's not what I'm saying. What I'm saying is, you are putting the cart before the horse, is we don't give charities the permission to act like business and until we do we should stop preaching to them that we want them to. And we should absolutely give them that permission. But you are right--board members come in and they say, we're going to run this place more like a business. Well, what they mean by that is: we're going to draw more blood from the stone. We're going to do even more for less. Which is the opposite of how a business becomes successful. Russ: Have you worked with some boards to try to change their mindsets? Guest: Yeah, I have. I do a lot of speaking around the country. I'm speaking to a local United Way board next week; a number of YMCAs, CEOs; there are always board members at the talks I give. And they react extremely well to this message. They don't know any better. They were raised on the same religion as the rest of us. And people lead busy lives and unless somebody educates them, how are they going to know? Russ: You mentioned the United Way. I'm not a big fan of the United Way. I don't know if you want to weigh in on this, but I'm going to just mention this because I think they are an example of the problem that you are talking about. The United Way's selling point is that they economize on fundraising costs--there is only one campaign and they have economies of scale. The disincentive is once you are in the campaign you don't have to work so hard to attract donors. And I give all my charitable donations to individual organizations because I think that model, the incentive effects are awful. Guest: Yeah. I haven't thought about that issue in particular. I suppose it's a little like term limits, which I'm not really in favor of because it lays off the responsibility for voting on this automated system: Well, I don't have to vote because I know in two terms the person will be out of there. Yeah. I think it ties into the argument I made about a broken marketplace. It isn't operating on the kind of dynamic up-to-date information that the consumer goods and services market does.
45:19Russ: Now, here's a question from EconTalk listener Justin Palmer, via our Facebook page; and I'd encourage people out there to like us on Facebook. Justin asks, "What about the charitable deduction? Should we keep it?" Given your encouragement of a for-profit mindset, do you think we should keep the charitable deduction? Guest: That's a big question. It depends on what we want to incentivize. If we want to incentivize more giving to health and human services charities, then I think we should. I think it's a way for the government to get services at 50 cents on the dollar, because they are losing $50 that they could have gotten in taxation but the donor is giving $100 to social services, so the government is up a net of $50 in services they otherwise would have had to provide to the tune of $100. But, I was reading Ken Stern's great book, Charity for All, and I had always been sort of unconscious about the distinction between non-profit and for-profit hospitals, and have always felt a little dumb because I didn't understand the difference. Well, after reading his book I didn't feel so dumb because there really isn't much of a difference at all. Russ: No, it's a sham. Guest: There is no difference. In that case, no there shouldn't be any tax exemption there if they are competing with the for-profit hospitals, and for-profit hospitals are actually providing a little bit more free care than the non-profit hospitals are. You have to ask about charities that run health clubs and things of that sort, where there is direct competition with for-profit industry. The Securities and Exchange Commission is not-for-profit, paid Grasso there tens or hundreds of millions of dollars or something. Russ: Large amount. Guest: So I think we really need to revisit that and ask ourselves what is it we actually want to incentivize. And limit the tax deduction to that. Russ: So, I really like your idea of imagining a world where charities advertise on Super Bowl Sunday, take out full page ads in the New York Times. You also talk about investment. What kind of investments are charities discouraged from doing now that they should be doing? Guest: Virtually anything other than capital investment in buildings and things. They are not investing their growth, because that gets labeled as overhead. That's the primary area. They are also not investing in their strength or their IT; they are not investing in their human resources; they are not investing in their talent, which is why you see high turnover, especially in the development field. It's one thing, it's bad enough to tell people we want you to work out of the goodness of your heart for two times, three times less than what you could make in the for-profit sector. And some people say yes to that. Oh, but on top of that we want to deprive you of all of the resources that you need to really capitalize on your potential. Now you've got a real losing proposition. Okay--I'm willing to work for less money, but I'm not willing to waste my life-- Russ: with my hands tied behind my back. Guest: Yeah, with my hands tied behind my back. Exactly.
49:08Russ: What about--you talk in the book about the possibility of some kind of stock market or capital market for charities where donors could invest. Explain how that might work. Guest: I guess initially, because you can't own a charity--the state owns the charity--one way around that would be to create for-profit charities where you keep the feature of tax deductibility but otherwise there can be equity ownership in the organizations. So you are still producing charitable goods but you are not putting them at a disadvantage by stripping away the ability for donations to be tax deductible. And some people say--well, a for-profit company, tax deductible? Well, there's a difference between tax deductible and a tax exemption. They shouldn't be tax exempt. They should be taxed on their profits. But they should be able to deduct all of the expenditures on charitable goods and donors giving money should be able to deduct that from their taxes under the simple theory that there's no benefit inuring to the donor. They are doing something with the hope of social impact. That would actually be one way to create a real stock market for charity, make these organizations for-profit, in some cases. Another way to do it, in the case of the tax-exempt organization, would be create debt markets, so that I could put money into the fundraising of a particular organization with the promise that I'll get 20% back, or 70% back because it's a high risk proposition. I don't own any equity, but I'm getting a high interest rate on the debt that I'm financing, that I'm making available. Russ: And I think to make that practical, you'd have to have it be some kind of standalone event. Because money is fungible. Money can cut across different activities. So, if you were doing, let's say I invested in the Pallotta Teamworks concept of a 3-Day Ride. I'd be lending you money for all the overhead you put up, all the investment you had to make in the tents and the food and the people, etc., before you had any donations coming in; and then you would pay me back a competitive rate of interest on that. Guest: Yeah, exactly. Russ: That would work. Guest: In the case of the Breast Cancer 3-Days, we launched that with a $350,000 investment. Over the course of 5 years it netted $194 million. So, we could have paid Venture Capital [VC] rates. If somebody said, I want 10 times my money back--okay, $3.5 million at $194 million net? Done. Russ: And the tragedy of that is how many events like that aren't taking place because they can't do that. Guest: Exactly. Yeah. Eventually we were able to get bank financing for our events because we were doing a lot of deposit business with one particular bank. You said you might have to limit it to one particular event. Not necessarily. A donor could say: Here is, whatever--AIDS Project Los Angeles, we raised $20 million for the year; they have a $2 million a year fundraising operation. I'm going to put $2 million more into their fundraising operation and I want a return of x percent on anything in excess of 10% growth in their fundraising department. And if the charity thought that's fair and that accurately assesses what our growth would be without the investment then they could offer a return on the whole development department.
53:16Russ: So, you have a great book; you have a great TED talk. A friend of mine just saw it; he's on the board of a charity and they all watched it and talked about it. You're causing, by yourself--I'm sure there are a few people who agree with you, but in general it's a little bit of a lonely effort you are involved in, right? There's something heroic about it, given this cultural barrier that you are trying to bring down. Is it a quixotic effort? Are you tilting at windmills here? Do you think we can move in the direction--let me say it differently: There's a lot of pro-capitalism stuff in your book, which jumps out, I think, at some readers. I love it, but some readers go: Whoa, whoa, I thought this guy liked charities; and he loves capitalism. So we have a cultural problem with capitalism already. You are suggesting we ought to embrace that and bring charities into that world. Which, I'm all in favor of as long as we let people take losses--that's real capitalism, not the crony kind. Can we get there from here? Do you have some optimism? Do you feel like there's some traction for your ideas? Guest: Yeah. There's this great quote by C. S. Lewis: It's not that Christianity has been tried and found wanting. It's that it has been found difficult and so has not been tried. And that's true of capitalism. We haven't tried a pure methodology of capitalism. And the evidence of it is that we don't use it in this charitable sector. If we did then we could start to not demonize capitalism; but we could beat capitalism at its own game. You use capitalism to promote love. Do I think we can change this? First of all, it's a paradox, but people in the sector, and very left-leaning, liberal people in the sector, get it. They toil all their lives and they see they are not having any impact and they are under enormous pressure to produce results with no resources to do it and they are absolutely fed up with it. They voted for Barack Obama and they have Nancy Pelosi bumper stickers and they love Uncharitable. You know. It is and it isn't a paradox. I have no doubt that 75% of the sector is behind it and wants to see change and recognizes this is an idea whose time has come. We are operating off of an ethic and off of a system that has religious roots and that is 400 years old and doesn't work any more. We need to change the way the public thinks about it. Okay, well that might be where it gets quixotic, one would think. I don't think so. I think you can change the way the public thinks about these things and I think you could do it very quickly. You can look at examples of it. Look at the way the pork industry changed the way people think about pork from a fatty heart-attack waiting to happen to 'the other white meat.' Or the way the egg industry changed the image of the egg as a high cholesterol food that was bad for you to 'the incredible, edible egg.' They just got methodical about it. The non-profit sector has remained utterly silent about these issues. It has no anti-defamation mechanism like other communities have, so it takes punches to the face in the media all the time and doesn't respond. It has no legal defense fund mechanism the way the Mexican-American community, the African-American community, the gay and lesbian community do, so its First Amendment rights are constantly trampled. It has no, you know, pork-the-other-white-meat advertising campaign where it actually tries to tell the media what overhead actually is. And it doesn't organize itself. There is no database where all 10 million people who are employed in the non-profit sector are listed and you could punch a button in order to get them to advocate on behalf of themselves. So we just need to do those things. And I'll tell you where my faith in the ability of us to change this comes from. One thing, like if we could change the way people think about pork, we could absolutely change the way they think about charity. But secondly, I happen to be gay. And I'm 52 years old now. And when I came out to my parents when I was 21, they were totally depressed and they thought: you'll never have a normal life and you'll never have a family and you'll never have children. Well, it's 30 years later; I'm married to a wonderful man that I've been with for 12 years; I have three beautiful children; they are our own biological kids. I could not have dreamed that that kind of change would have happened in the United States in the course of those 30 years. But it has. If we can make that kind of change on something as polarizing as gay rights and gay marriage, we can absolutely get people to think more rationally about charity.

COMMENTS (38 to date)
Chip Morris writes:

Fantastic interview. As a champion of free markets and a professional in arts organizations, I found Mr. Pallotta's view incredibly stimulating and insightful. He is focused on charity, but I think similar issues infect arts giving. I have a foot in both the private and non-profit sectors: I own a for-profit arts school, and I am head of a non-profit performing arts company. Bravo for recognizing that one can be passionate for a cause (dance) and still make money at it (teaching).

I think the truth is that all arts funding should be private. People can vote with their personal funds as to what arts to support. Battling over government grants diverts ridiculous amounts of resources from actually making art.

That said, could the argument be made that (non-pop) arts are a public good? Hmmm.

Keith Vertrees writes:

Yes, we want to know whether charities are solving the problems. However, the sole metric Mr. Pallota gave us for his efforts was the $500+ million he raised for AIDS and breast cancer charities.

How many AIDS patients were cured? If none, was this charity worthwhile? I believe drug companies are already strongly incentivized to mitigate symptoms, so what was the charity's goal?

Similar question for breast cancer.

In other words, if Mr. Pallota wants us to evaluate charities on their merits, we need metrics other than the amount of money they have raised.

BZ writes:

Another great econtalk. I only saw the TED talk a week or two ago, and my thinking was transformed by it, so this was so timely for me. Thanks Dr. Roberts!

@Keith -- look at the 36:00 mark, where he addresses your question.

Listening now, and just heard this ...

Guest: I had always been sort of unconscious about the distinction between non-profit and for-profit hospitals, and have always felt a little dumb because I didn't understand the difference. Well, after reading his book I didn't feel so dumb because there really isn't much of a difference at all.

Russ: No, it's a sham.

Guest: There is no difference.

I would love to hear more about this angle. I've wondered about that myself.

The difference is between taxable and non-taxable corporations, not profit and non-profit. It's hard to see how a govt. agency having the power to anoint some 'non-taxable', is even constitutional. Seems like that violates the 14th Amendment.

I'd first advocate eliminating the corporate income tax completely. If that won't fly, then eliminate the charitable, educational, 501C (3&4) and whatever other distinctions exist. If an organization is truly benevolent they'll give away the money they raise and there won't be any profits to tax.

Robert Shiller has been promoting the idea of a 'benefit corporation' that has been adopted in a few states lately. That might be a way to go.

Dan writes:

While the guest raised some great food for thought, I'm wondering why anyone would bother operating a for-profit company if there were minimal restrictions on non-profits combined with all of the tax benefits he recommends.

In my home city of Providence, Rhode Island, something like 1/4 of the land is occupied by a "non-profit" or "historical building." Many of these organizations are functionally indistinguishable from for-profit businesses, but they reap all kinds of tax benefits based on their status. It's like how when government is paying out generous SSDI benefits in a recession for "disabled" persons, all of a sudden everyone realizes how they are in fact "disabled."

Russ,

You were talking with Dan about how their needs to be an organization that measures the actual effects achieved by organizations, not just simplistic measures like overhead ratios.

There is such an organization, and it has very high epistemic standards.

It is called GiveWell: givewell.com.

Holden Karnofsky would make a good guest on your show, actually. He is quite knowledgable about cost-effectiveness in the charitable sector.

Stephen writes:

I'm halfway through the episode now. Smart guest, but I think he's missing something.

His main theme is: don't think about charities with your heart, think rationally, practically. But I think our intuitions are grasping something that he's missing when we feel uncomfortable giving to charities with highly-paid executives.

There are 3 increasingly uncomfortable ways to use our money: 1) Spend on ourselves and kin. Easy. (2) Give to strangers less fortunate than ourselves, trying to "pull" them
to our level. (3) Give to strangers more fortunate than ourselves, essentially "pushing" them up even higher.

Giving to charities with well-paid execs feels like #3, whereas our intention was #2. He needs to at least acknowledge that dynamic before explaining why people should overcome it.

Alai writes:

"You have to ask about charities that run health clubs and things of that sort, where there is direct competition with for-profit industry."

So, health clubs-- and organized bike tours, maybe?

"Charitable giving remains stuck at about 2% of Gross Domestic Product (GDP) ever since we started measuring it in the United States in the 1970s."

In that case, maybe spending more money on fundraising and administration--even if it benefits that particular charity--will only cannibalize other charitable giving?

Stephen writes:

My previous comment was supposed to read:
...(2) Give to strangers less fortunate than ourselves, trying to "pull" them UP to our level...

(so, could you remove the \newline from the middle of (2), and replace it with the word "up"?)

Thanks

Lauren writes:

One matter that wasn't brought out in Dan Pallotta's otherwise thorough, on-target observations was that board members of nonprofits are also unpaid. The laws/rules/culture of many states as well as the IRS make it almost impossible to pay board members.

That has a lot of consequences.

Even though it is quite legal for nonprofits to pay their board members, to do so--particularly for a small, start-up nonprofit--would likely result in the nonprofit being denied its legal not-for-profit status at either the Federal level [501(c)(3)], the state level, or both. Paying one's board members counts as a big negative in granting legal not-for-profit tax status. That's not just a cultural matter--it's a legal matter, too.

What I'm adding here to Pallotta's excellent observations is that the codified legal definitions of what counts as overhead and what legally qualifies for not-for-profit status reinforce and feed back into the inability of nonprofits to attract top-notch talent, to invest, to innovate, or to grow. If remunerating board members results in your being denied not-for-profit status at the get-go, or having your status revoked, obviously you can only hope to recruit board members who are willing to work for nothing.

If you can't pay board members a market rate of return, you lose out on the best of the potential outside oversight and innovative contributions--such as Russ suggested in the podcast might be feasible. Board members--in most states, 3 or more of whom are required to be legally recognized as a not-for-profit--are ideally selected from amongst the most knowledgeable, energetic, established, objective community members. That is, from folks who come ready-to-work at a high level with business experience or other accomplishments and who are interested enough to give up some of their valuable time while bringing outside experience and objectivity to the organization. That combination makes them hotly contested in a small city or community, and perhaps even more so in a big city or national environment if one wants to expand one's horizons. A successful or growth-oriented not-for-profit cannot hope to compete for the big talent unless, by sheer coincidence, one of these rare folks happens to have enough interest in that group's goals to be willing to do it for free, sacrificing time and income from serving on the board in the for-profit sector or time otherwise devoted family or fun.

If you can't pay someone a cent, much less anything near their competitive market compensation, all you can offer is some kind of psychic reward such as the ability to say, "I'm on the Board of such-and-such." That doesn't cut it for hotly contested talent, ideas, and skills, much less for the specific sorts of skills a group might want to evaluate, improve, or expand. In a possibly neutral case or only mildly negative case, you staff your legally-required board with a few already-available, talented, devoted volunteers who are already working for free and who might or might not have some extra skills and time. In the worst case offering a chance to be the board, though without pay, will systematically attract outside folks whose motives are primarily power and hobnobbing with the upper echelons in the community rather than those who are offering--perhaps in addition to the reasonable side-benefits and enjoyment of power and hobnobbing--true skills, loyalty, commitment, and creative ideas.

I speak from some experience. I head a small nonprofit charitable organization in my local community. We serve hundreds of local folks annually and are well-respected as a successful, long-standing organization. We have no lack of dedicated, high-quality volunteers. But, all of us--who all work for free at every level--are part-time. When I looked into expanding our successful operation--both locally and nationally--my first idea was: Let's start by attracting some folks with skill, experience, and talent in such areas, starting with paying for top-notch, objective, outside board members to help us focus on long-term planning and how to move forward in the short run with those goals flexibly in mind. Why waste a few years and a bunch of money floundering around when we know what we want to do is take this working model to the big time based on existing experience and creativity?

Sounds like a sensible plan, eh?

Our immediate discovery was that our doing that would likely instantly deny us any not-for-profit status--by the state government, Federal government, or both. Even though none of our staff or volunteers are paid even a cent; even though there is no building structure involved or barely any other costs for our program--nothing that the public thinks of as "overhead" when they casually are asked what that word means to them. Our interviewing and offering to pay anyone such as a board member anywhere near a market rate for qualified expertise with an eye toward our future development would instantly mean that our temporary "overhead" would instantly surpass the limits or allowances granted by laws, statutes, or nervous/grandstanding public officials for what qualifies as a "not-for-profit."

And in the worst of all Catch-22's, even though we as an association of unpaid, dedicated volunteers, would have been willing even to make the group a for-profit (and yes, we compared all kinds of in- and out-of-state options, L.L.C., incorporated, and even other options)--even if we'd have to pay all taxes ourselves on donations, in order that we might merely ourselves be allowed to finance the payments for the expertise we could attract in a few quality board members so long as perhaps we could each hope to recoup those advance payments later in the form of even drawing temporary salaries after a year or two or draw returns on loans or capital even at a zero rate of interest or return--the immediate legal result was clear: as soon as we might become a for-profit, there was no longer any way to compete successfully for donations. No matter how much donors might be passionate about our cause, the tax deductions they could receive by contributing to alternative charities they might appreciate as a second-best to us in an even playing field would so heavily outweigh their personal advantages in donating to us that we could not realistically ever recoup our up front finance costs even at par. The wait time involved for state and Federal determination--up to 5 years at the Federal level--and likelihood that we would be denied not-for-profit status would we try for it was deterring. Whether as a not-for-profit or as a for-profit, we were thwarted at every pass to expand.

We decided to remain small.

We are frustrated often at how much more we could bring and how great the demand for our services outside of the local community we serve.

Small not-for-profits are essentially clubs. Clubs are great! Don't get me wrong. But clubs don't usually have 5-year plans or investment plans or any growth prospects. There's a reason for that.

Thomas Stanley writes:

There have been a lot of interesting EconTalk episodes, but this is the first one that is likely to change my life. (I'm only at 10:28, hopefully the rest is as good.)

Like a lot of good ideas, the principle articulated by Pallota seems obvious in hindsight. It makes me wonder why I never thought of it myself, why I just accepted the conventional wisdom. I don't think I'll ever view charity in the same way.

I have never known much good done by those who affected to trade for the public good.
Good to keep that in mind.
Walter writes:

Pallota said that government should find it some benefit if charity is tax deductible in that their burden would be somewhat lifted. The assumption there is that doing good is a more significant motivation than more control.

Brit writes:

Okay, I guess I'm going to be one of the few people who's going to be critical of Pallorra's ideas. There were a number of things in the podcast that bothered me.

The first was his tendency to use bad analogies or comparisons when comparing for-profit with non-profit entities.

For example, "The fact that we were able to do it for $.40 on the dollar was remarkable. Picture any kind of a vacation industry that had to show a 60% margin on something like that, right?" That's a total apples-to-oranges comparison. When we're talking about charities, we're talking about people *dontating* money - the more money they give the better they feel about themselves. When you go on vacation, people closely scrutinize what they're getting for the money. It's a whole lot easier for a charity to say, "Donate $1000 to cancer and we'll provide you with 9 meals and a tent!" than it is for a vacation resort to say, "Pay us $1000 and we'll give you 9 meals and a tent!" In the former case, you expect that any money not being spent on meals and tents is going to a worth cause of curing cancer. In the latter case, you feel like you're getting ripped off. It's apples to oranges.

Another problem for me was Pallotta's charged language to get people to pay charity CEOs what they're worth in the open-market (example: "I think it's arrogant to impose your morality and your ethic on everyone else. If that works for you and you are happy, great. Wonderful. Good for you."). Who are those people who are "imposing their morality"? It's "only" the people donating! I'm sure Pallotta has no problem with consumers boycotting products for whatever reason, but suddenly he has a problem with people boycotting charities because they feel the CEO is overpaid? That seems like a double-standard. Here's the thing: people are *donating* money to the charity. This is a different situation than when you *buy* a product. What this means is that people are sacrificing for a cause when they donate. It's understandable that they want people involved in the charity to also sacrifice (and not view it as a money-making opportunity). Also, people need to trust the charity. If I go and buy something at the store, I see this as a more-or-less exchange. I can then scrutinize that purchase: is the iPhone I bought worth the money that I paid? With charities, it's different. I give money and that money disappears down the rabbit hole. Presumably, that money goes to cancer research or for food in africa or whatever. The point is that I am in *no* position to scrutinize whether that money was spent effectively (like I am with an iPhone). Someone else is getting the product of that money, and nobody really knows if the outcome of that money was worth the value of the money I spent on it. (To put it another way: imagine if you walked into an store, paid $100 for an phone and then they sent it off to someone in a third world country that you will never talk to. Was the phone worth $100 or was it a crappy $5 brick? Did the person use the phone? Did they have any cell-phone service? You have no idea. You aren't in a position to evaluate the value of that $100 purchase/donation.) My point is that this puts people who donate to charity in a position where they must have a large amount of trust in the organization. When CEOs are taking big salaries, it erodes that trust. It makes people think that maybe this is merely a money-making opportunity for the top-level management. In fact, it's entirely possible that an honest charity (ten years ago) gets slowly infiltrated by board members and CEOs who see the charity as a money-making opportunity, and they increase their salaraies "because they deserve it" - effectively turning a once-good charity into a money faucet all the while gaining the "philanthropist" label in the process. (I could imagine scenarios where, say, the Red Cross is donating $1 billion a year, each year. Meanwhile, the CEO's salary increases from $1 million a year to $10 million a year to $50 million a year. The whole time, he can say "well, I deserve it". The problem is: where are the checks and balances? The public doesn't trust board members anymore. We sometimes feel that the board can get filled with a bunch of yes men. What's the solution in that case? The public should stop funding the charity and cause it to fail (as if the public could ever act in a unified way)? Pallotta seems to think it would be "imposing our morality" if we stopped funding the charity in response to $50 million salaries. What's his solution to the problem? Are we just supposed to turn into "yes men" and say, "Gee, if the board thought that $50 million is "worth it" then I guess I have no choice but trust them and trust that they're not a bunch of yes men, and trust that they know what they're doing, and trust that they're not giving kickbacks to each other?" Pallotta seems intent on vilifying people who questions the board's choices.) I would like if Pallotta would acknowledge this asymmetry which makes non-profits different from for-profits.

At one point in the podcast, Pallotta harps on the fact that if a charity with low overhead, you still don't know if the food they're giving away is rancid. This is true. However, it's just as true for for-profit charity as well. He should acknowledge that for-profit charities have all the same potential problems as non-profit charities and more -- they have the additional danger of money-hungry CEOs gobbling up the cash. One can imaging scenarios where a "homeless charity" is serving rancid food in order to cut costs and pay the CEO more money.

I was glad that Pallotta talked about other (better) ways to evaluate charities, but I think that task is a lot more complicated than he acknowledged in the podcast. I can imagine lots of complications to evaluating charities that probably won't get accurately captured anytime soon. For example, if food is given to African countries, that seems good, right? But what if it undermines local farmers, thereby weakening the economy, producing longer-term negative effects on the ability of the african country to pull itself out of a cycle of dependency? There are plenty of complicated effects that charities can have, and I don't believe they'll be captured anytime soon in a number. Pallotta talks about how people want giving to charity to be easy, but people need to do their homework. Well, my counterargument to that is that: it's a lot more difficult to get good information on charities than he seems willing to acknowledge. Secondly, any intelligent for-profit company would make it as easy as possible for consumer to buy products, but suddenly Pallotta wants to put the onus on the consumer (i.e. the donator). I work in software. One thing I'm very committed to is making things as easy as possible for our customers. I understand why people want to use a Mac or Windows instead of using a Linux command-line. I never get pissy with people and tell them, "Using computers is hard work. Learn to use the command line. Stop being lazy." No, I go out of my way to make it easy for the consumer (our customers). Pallotta is going down the wrong path if he's just going to tell donators that they need to "stop being lazy" and do all this independent research to make sure their charities are using the money well.

I'd also like to point out the fact that when charities advertise to get more money, this my be partially a zero-sum game between charities. In other words, if one charity does a lot of marketing and increases their revenue from $100 million to $500 million, there may be other charities who are getting a reduction in revenue as a direct result. In other words, people might say, "Well, I already gave to that cancer charity so I feel less inclined to give to the homeless charity." In that sense, there are externalities that aren't getting captured by a simple "we increased revenue from $100 million to $500 million". With heavy advertising, I would expect that the percentage of GDP would increase above 2%, but it's not infinitely expandable. I could easily imagine a scenario where charitable giving increases from 2% of GDP to 3% of GDP, but all the increased marketing, increased competition between charities, and increased salaries means that no actual increase in funds goes to the cause. In that scenario, nothing good has happened even though "Yey, we increased national donations by 50%!"

I'm not saying that nothing needs to change in the non-profit world. I am saying that Pallotta doesn't seem to talk about the huge fact that people who donate money are massively dependent on trusting that the money is going to be spent well and isn't a money-grabbing opportunity by overpaid CEOs. If you're part of a charity, I can understand this whole "just trust us" attitude because having other people trust you is always a winning proposition. But being on the other side of the fence hearing someone else say "just trust me" is a lot different. Pallotta needs to acknowledge and address that fact.

Dan writes:

There's a parallel between the guest's argument regarding non-profit compensation and the "you have to pay for talent" justifications I frequently hear in defense of six-figure bureaucrat and municipal worker salaries. The guest fails to appreciate that these cultural restrictions play an important role in maintaining the public's trust. Not everything is in the details - it's sometimes important to avoid even an appearance of impropriety. When you have Boston firemen and police raking in $150k, for example, it creates a perception of corruption and unjust enrichment that does incalculable damage to the relationship between government and the governed. Whether the compensation results from overtime or some other "legitimate" factor is besides the point that it looks bad, and perception matters. Similarly, a non-profit president earning millions gives the impression of excess and abuse that will damage the public's trust in charity and nonprofits generally. Especially if you want special tax goodies from government for your non-profit organization, it's reasonable for the public to ask that compensation be sacrificed in return for your special status. Again - if there were no cultural or legal restrictions on nonprofits, why would anybody operate a for-profit business?

Michael writes:

Golly. I've always wondered why we can't seem to attract top performers to serve on the supreme court. We need to start compensating these justices or the best lawyers will stay in private practice. That's just common sense.

But seriously, this is a straw-man argument if I ever heard one. I don't have a problem with the president of non-profit making more than the president of the United States. I have a problem with the president of any company making more than the president of the United States.

When I hear Jamie Daimon is taking home $18 million dollars, I don't think, wow, that guy is generating impressive value for JPMorgan. I think, wow, that guy is extorting is employer impressively. I wonder what dirt he has on the board members. Or do they really think they couldn't find 36 guys who for $500k apiece couldn't run the company into the ground with equal aplomb?

Okay, so if I'm doing business with JPMorgan then I'm being sufficiently bribed or coerced to keep my mouth shut about the boss. But when it comes to charitable donation or, really any discretionary purchase, I am inclined to notice if my counterparty has money to burn on executive compensation or Superbowl ads and to wonder if I might not get a better deal going with someone whose cost structure is more product and less flim-flam. That's just me I guess.

Also, not for nothing, it would help if Pallotta were more of a disinterested party and not arguing in favor of me spending more money on his services specifically. Seems kind of self-serving.

Mateo writes:

Almost pure nonsense.

If he honestly believed what he was saying, he would advocate to eliminate the tax deduction for charitable giving (e.g. after tax dollars from corporations and individuals).

Additionally, people in the non-profit sector are well compensated, despite his plea to the contrary. It also supports many for profit planning organizations like his own (I give him credit for owning up to that).

Finally, I agree that charities should be judged on performance. The last time I reported to my board of directors, cost was a pretty big component of performance.

Timple writes:

I was going to make some similar comments to Brit - but (s)he did it much better than I could have.

He made a good point that the nurse is just the same a philanthropist as Bill Gates (and more so if she gives away more %-wise). Jesus summed this up nicely in Mark. http://www.biblegateway.com/passage/?search=Mark+12%3A41-44&version=NIV

The picture of a nurse donating a good proportion of her income to a charity where the top management are on 6 digit+ salaries does not feel right. Mother Theresa did great work (possibly even more so than Pallotta!) but she didn't end up a multi-millionaire at the end of her life.

He has made a lot of money as a for-profit company offering services to charities and fair-enough he risked his own capital. But it is not for charities to be doing this. I have no problem with charity workers earning multiples of the median wage to enable them to live comfortably but the figures he quoted were way beyond that.

The winner-takes-all world currently developing where the lucky 1% (and there are very few genuine entrepreneurs in this lot) take 90% of the resources is not the model for the charity sector (at least not any charity that wants a donation from me!)

I have a problem with the president of any company making more than the president of the United States.

Barry Goldwater had the answer to that almost half a century ago. He said he'd rather live in a country where you had to be a millionaire to get to be President, than in one where you had to be President to get to be a millionaire.

CC writes:

Brit summed up some of my criticisms. Especially:

I'd also like to point out the fact that when charities advertise to get more money, this my be partially a zero-sum game between charities.

I was surprised that Russ didn't make this counter-argument. If a charity can spend $2 million on marketing and raise $3 million as a result, it's not as if they've done $1 million of "good". More likely, they diverted something like $2.8 million from other charities and increased total donations to all charities by $0.2 million. So it was a waste.

Even if it wasn't, so what? Let's say they really "created" $3 million of "new" donations at a cost of $2 million. Is that a better state of the world? It's actually not obvious to me.

Finally, some of these charities are attacking problems that don't even make the top 50 list of urgent causes. You don't know how many times I've heard, "You should donate to my walk-a-thon to fund fruitless research into disease XYZ. It's a worthy cause since my friend's nephew had that disease!"

I think Bill Gates has done a lot to avoid these pitfalls. He's given a lot of thought into how we can put big dents into major problems affecting many people.

Matt writes:

I have seen a lot of counter arguments to Palotta's ideas that ask whether more aggressive "overhead" would divert funds away from the needy, suggesting the total amount of charitable donations is fixed. It's pretty clear that in the rest of the economic world, businesses behave as if the size of the pie is growing and market share is there for the taking. Why would we assume charity is somehow different? If they have more incentive to give, why wouldn't they give more?

Adam S writes:

Excellent podcast. It makes a ton of sense that you want the most qualified people running any organization (including a charity) even if their compensation is more expensive. You get what you pay for (at least some of the time).

A few issues:

1) Since charitable giving is fixed at 2% of GDP, it seems that raising overhead costs will just transfer money from the actual cause to admin. Perhaps Palotta's plans haven't taken off yet, with the goal being to raise that to the 3-4% range. And it also sounds like the organizations that took over after firing Palotta actually raised their overhead costs, but it still seems like in the short term, the actual money getting to the needy could shrink until the 2% level is surpassed.

2) I think Palotta's point on personal responsibility is excellent. But then I cringed when I heard him discuss the iTunes of charities. That seems like more or less another charity evaluation website that gives out gold stars for some arbitrary metric. Do the charity reviewers go and taste the soup and the soup kitchen? If a given charity for cancer research spends only 5% on admin costs but their scientists don't discover anything very useful, how many stars does that charity get? It just seems like it's nearly impossible to quantify the effect of a charity unless you're working there yourself, and even then it's difficult. Maybe the government could do the same for cheaper. Maybe another charity could. So, I think it really comes down to personal research and preference rather than any objective metric you can decide on.

3) Regarding government max limits on admin spending (when charities accept their cash), I think this is just a manifestation of serious risk aversion. Voters by and large still don't think charity CEOs should rake in the big bucks, and they would be furious if their tax dollars went towards charity CEO salaries versus making soup at a soup kitchen (even if the soup is rancid). Admin costs seem to have a better chance of being "wasted", so politicians are only protecting themselves from voter backlash. It seems a very logical response.

If US banks were more democratic in their shareholder relations, there's no way most shareholders would accept the levels of risk taken on by many of these firms. Maybe the shareholders would be poorer overall as a result, but you'd also avoid major financial crises.

Lauren writes:

It's easy and might seem obvious to argue that if one charity gets more, or if charities get more in total, it's a 0-sum game--so someone must get less.

I think that's a misunderstanding of Pallotta's argument.

Zero-sum games certainly can happen if everyone is doing the best possible with existing resources. Or, as economists term it: if you are on the production possibilities frontier.

If you are off that frontier, though, there are potentially large gains to all merely by reorganizing or otherwise using the existing resources.

Pallotta is arguing that regarding charities, we are so far off the production possibilities frontier that merely by reorganizing and deconstraining charities, everyone can gain, and gain big. That's not 0-sum. It's an argument about doing better with the resources we have.

Craig Fratrik writes:

I just wanted to echo what Luke said above.

GiveWell is committed to many of the actual effectiveness measures you discussed. I highly recommend their blog and reading about their approach.

Russ Roberts writes:

What some commenters seem to be missing is that Pallotta is arguing for creating incentives to make charities more effective. If you pay your workers more and get better results, the fact that less is "going to the cause" is irrelevant. That's not what I care about--I care about curing cancer or improving the school system. I don't care if less money goes to those activities but because of more skilled management, the money is more effective.

David Jinkins writes:

I was surprised that givewell.org wasn't mentioned in the charity watchdog discussion. Givewell does look at impacts, it is very open about metrics, and it is easy to use. I agree that we should care about impact first in charitable giving, but that doesn't mean that easiness is the enemy!

Drew Yallop writes:

Charity performance ... Have you seen the "Give Well" blog?

John Berg writes:

I don't think I've heard anyone discuss the following example of a charity:

A classmate of my daughter(a certain number of years back) was tasked by her church to open a free K-12 school in Guatemala. We've followed her experiences over the years as she dealt with bandits, earthquakes, penury, health problems, and unreliable communication channels (currently via her parents). She is now celebrating the fact that many of "her children," (she never married) are attending High School.

I consider her very effective.

John Berg

John Berg writes:

One commentator had it right: the distinction is between "non-profit" and "non-taxable." Consider NPR and its new plush headquarters in DC; or the suburban YM/WCA with its health club facilities. Does the Catholic Church shelter its hospitals, nursing homes, hospices, and childrens facilities as non-profits or as charities. Does my university claim to teach for charitable purposes or because "the power to tax is the power to destroy."

As one commentator noted, did the Constitution include a provision for rewarding the compassionate?

John Berg

Davida writes:

Pallotta's basic argument is convincing, but the challenge --- the BIG challenge --- is to develop appropriate metrics to judge charitable success.

It's a little weird to discuss how to judge Alzheimer's research, say, without mentioning the NIH or NSF, both of which do quite a bit to evaluate results of their grants. A charity could piggyback on that expertise. One simple way would be to take grants that were only partially funded and add back the missing money.

And it was a bit disappointing when Russ attempted to squeeze everything into his ideology. It's more sensible to ask, when does each approach make sense?

Government has scale, universality; it is there without publicity. It has problems with innovation because of all the safeguards we voters demand to avoid scandal and fraud. And like any longstanding organization it tends to become sclerotic. It can provide a baseline level of service; just don't expect it to be innovative.

The United Way is appropriate for low-cost, local fundraising. It essentially vouches for the local charities, and it helps provide baseline funding to a large number of small, local organizations, most of which have volunteer leadership, and most of which I simply don't have the time to check out in detail. (Anyone want to argue against division of labor?)

If someone is doing something truly innovative, something with the opportunity for scale, then the massive scale approach of Pellotta TeamWorks makes total sense.

And every charity ought to think big about metrics for success, because minimizing overhead is the road to minimizing impact.

John Beitelspacher writes:

Fantastic episode! Enough said.

Luke J. writes:

I enjoyed this conversation. The idea that non-profits could take market share, not from other non-profits, but from the for-profit sector by allowing non-profits competitive tools seems completely obvious. And yet, it has not happened.

Joe Nunes writes:

There is a nugget of good in the podcast which is the idea of more effective measurement of charitable outcomes.

As I was listening I was astounded at the absence of discussion about the fact that if we spend $100 million to raise $110 million with a net $10 million to the charity - the donors will have $110 million less to direct elsewhere.

The only truth should be a discussion on value. What outcomes do we get for what input (costs).

I am fine if we collectively donate in the above scenario if the net $10 million finds the cure for cancer and I am not so happy if the net $10 million buys sleeping bags for the homeless which we could have done much more effectively locally on a smaller scale.

Dave G writes:

Lots of good stuff in this interview, but I want to hone in on the Zero-Sum Game question and (certain types of) overhead. Perhaps some overhead for salaries and awareness campaigns are warranted, but Pallotta's multi-day events strike me as genuinely wasteful and must certainly crowd dollars out of genuine care/research/etc.

I posit that non-profit donations are highly inflexible and are thus a near-zero-sum game. Innovation and marketing may be able to "expand the market" for small (forgettable) donations. But larger tax-deductible donations are more a result of tax policy, perceptions of one's prosperity, and one's charitable inclinations. Only one of those is subject to marketing (charitable inclination) and in my case...not very.

I finally refrained from giving to my friend's AIDS Ride campaign every year once I realized I'd paid a cumulative $600 for tents, meals and after-parties. As a sample of n=1, my donations didn't decrease, but simply moved to lower overhead groups (that I believe are equally or more efficacious).


Will Bell writes:

I think that Dan Pallotta is utterly misguided and his views should be treated as extremely radical and completely unimplementable. The fact that he was able to parrot off such implausible ideas (for profit charities with a capital market for trading, doesnt this already exist with ethical investing?)without any challenge from Russ was disappointing as similarly left of centre thinkers are rarely treated with such adulation and fawning respect.

I wont go into the myriad reasons that the ideas Pallotta puts forward are misguided historical context - there is a reason that the whole charity structure was set-up in the first place, human nature - allow unscrupulous people to pretend that they are raising money for a particular cause without actually making them disclose what they do with the money, measurability - the only metric he is able to refer to is money which is demonstrably flawed in the charity environment. Instead I'll refer to personal experience;
Many of the people I worked with/against in the financial sector are now firmly ensconced in the charity sector. Why? Because in Finance there are laws that require you to disclose the commission you make on a financial product. In the charity sector you can earn 100,000 p/a and make 200,000 in donations (an effective commission rate of 50%) and there is no disclosure at all. The more you create a market system for charities, the worse this will become as it is in effect a financial market. We have seen what deregulation achieved in finance.

Gandydancer writes:

The only good idea mentioned in this podcast is eliminating the charitable deduction. Then if you want to overpay for bike tours or give Mr. Pallolta multiples of your wage so he can take better care of his parents than you can and travel with his children around the world it'll be a case of doing what you want with your money and the taxpayer won't be on the hook for anything more than the law enforcement to police fraud.

Jay writes:

thoroughly interesting podcast.

I take some of Mr Pallotta's points to heart. It seems like his points may make a lot of sense for his type of public health issues.

However, It does seem like some charities suffer from a problem that the people at the top are disconnected from those at the ground level. The Girl Scouts comes to mind. I have read about 6 figure salaries of CEOs. One troop forced to sell cookies it accidentally over-ordered. Was there a noticeable benefit to that Ceo's pay? What do local troops get for basically donating child labor?

The other interesting point was the large amount of charity is donated to religious organizations. the fact that these organizations also donate a large portion of their income to social problems like homelessness seemed to be overlooked.

keep doing that voodoo that you do Russ.

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