An essay on the grave funding crisis that faces the nonprofit sector, which VPP Chairman Mario Morino shared with the VPP board of directors in October 2002

In the wake of the September 11 terrorist attacks and in the midst of a continuing economic downturn, a number of storm fronts have collided, reducing the supply of funding for many community-based nonprofit organizations and greatly increasing the demand for their services. The colliding fronts include the decline in public and private equity valuations, the implosion of the high-tech sector, the rise in unemployment, the expiration of welfare term limits, incongruously high housing prices, severe state budget shortfalls, and the new federal budgetary demands of domestic and international security. Even here in the National Capital Region, where increased government spending is providing a stimulus to the economy, this collision—plus the donation-depressing financial scandal at the United Way of the National Capital Area—has altered the climate in which nonprofits and philanthropic institutions operate and likely will continue to do so even after the nation’s economy turns around.

To help our region navigate these challenges, there is a need for a comprehensive effort to map the various factors at work, to better understand what kinds of pressures they will exert over the coming years, and to define short- and long-term strategies for tackling the factors head on. This need is particularly acute in the world of community-based nonprofit organizations, which were already stretched thin organizationally and financially well before the current economic downturn.

Situation Analysis: The Supply Side
Although charitable giving is certain to rise over the next 20 years as trillions of dollars of family wealth transfers from one generation to the next, individual and foundation giving will be down significantly in the near term. Many people feared that the generous donations to September 11 relief funds might crowd out donations to other important causes, but it now appears that this did not happen. The downturn in individual, foundation, and corporate giving has been driven much more by the overall downturn in the economy and equity markets.

In 2001, overall charitable giving by individuals, corporations, and foundations declined in real terms by 2.3 percent from the previous year. This decline, of course, would have been steeper if not for the outpouring of donations for 9/11-related causes. Next year’s figures probably will be worse. During Q1 and Q2 of this year, assets of nine of the ten largest private foundations had fallen by $8.3 billion. The David and Lucile Packard Foundation is an extreme and sobering case. In 2001, the foundation gave away $460 million; because of a dramatic decline in the price of Hewlett-Packard stock, the foundation expects to award only $250 million in grants in 2002 and $200 million next year. “We are cutting back across all of our programs,” the Packard Foundation’s CFO said recently.

In 2000, the ten largest individual gifts to charity totaled $11.1 billion. In 2001, the ten largest gifts totaled $4.6 billion, down nearly 60 percent. Of course the slumping values in public-equity markets is playing a major role in this sort of decline. Far less obvious is the psychological effect of greatly deflated private-equity valuations. Because of a severe case of the “reverse wealth effect,” many high-net-worth investors and entrepreneurs who were willing and able to make donations of more than a million dollars last year are now struggling to write checks of $25,000, as they find their investments in venture funds devalued and highly illiquid.

The declines are falling particularly hard on small, community-based organizations, especially those that have not built effective fund-development capacity. People appear to be more likely to maintain their gifts to organizations they know very well and have a long relationship with—churches, colleges, and hospitals—rather than small service providers that are far less familiar to them and do not have sophisticated development staffs. “I have never seen anything like this,” Fran Barrett, who has worked with community-based nonprofits since 1969 and now leads New York’s Community Resource Exchange, told The New York Times. “Usually when one well runs dry, you can run to another and the only question is whether you’re quick enough to where the money is. The money isn’t there now.”

To date, California has released one of the most comprehensive studies assessing the extent to which these small service providers are experiencing shortfalls in donations. California’s survey of 413 nonprofit providers of safety-net services to low-income residents showed that, on average, these organizations had seen a drop-off of $62,000 donations this year. Extrapolating out from this sample, service providers across the state of California may have lost $300 million in donations this year.

While many forms of charitable giving are likely to rebound after the economy turns around, federal funding, which accounts for a larger portion of nonprofit revenues than does charitable giving, is a major long-term concern. When you combine the effects of the economic downturn, the large tax cut that was signed in the summer of 2001, and the new demands of homeland and international security, we could be looking at significant cuts in social services for many years. Social service dollars are particularly vulnerable, because certain areas of discretionary spending, such as funding for first responders will only increase.

In just the past two months, federal budget forecasts have taken a significant turn for the worse. The Congressional Budget Office estimated as recently as last year that the country would run up a budget surplus of $5.6 trillion over the next ten years. By January 2002 the projection had fallen to $1.6 trillion. And in August 2002, the figure fell to $336 billion. In a year and a half, more than $5 trillion in projected surpluses vanished.

How did so much money disappear so quickly? About 20 percent of the decline can be traced to increased spending, primarily on defense and homeland security in the wake of September 11. Another 40 percent is the result of the economic decline and technical changes in the estimate. The remaining 40 percent is the direct result of the tax cuts signed into law by President Bush last summer.

The state situation is just as disturbing. Across the country, states are facing budget shortfalls of about 10 percent, on average, and most states do not permit themselves to run budget deficits like the federal government does. As the economist Paul Krugman reported in The New York Times, “a budget shortfall of 6.5 percent in the early 1990s led to severe cuts in services and … this [situation] looks considerably in 2003. The National Conference of State Legislatures predicts that the gap between available tax revenue and budgeted spending will rise from $37 billion this year to $58 billion next year.

Virginia Govenor Mark Warner managed to close a $3.5 billion budget shortfall in the spring of 2002, but it wasn’t enough. In August 2002, he told state legislators that the state was facing an additional shortfall of $1.5 billion. He said that the Commonwealth will “be forced—out of necessity—to reconsider what is typically considered exempt” from cuts, including primary and secondary education and health care. Yet another round of budget cuts is looming, and children’s advocates are worried. For example, Healthy Families Virginia, a public-private partnership aimed at preventing child abuse and neglect, has been long been championed by the Lisa Collis, the First Lady of Virginia—and yet its budget allocation may well be cut. “It’s a nervous time for us," the program’s director recently told The Washington Post. “We know that another billion dollars has to be cut…and when the General Assembly session comes, all the money will be up for grabs again.” According to Mary Agee, president of Northern Virginia Family Service, “Most of our health and human services that are not mandated are being looked at very closely, given the seriousness of the budget cuts. . . . It’s just a tragic situation to be facing these choices.”

Maryland and DC are deep in the red as well. Maryland Governor-Elect Robert Ehrlich faces a $414 million budget deficit this year and a looming $1.3 billion gap in 2003. Meanwhile, DC is working to close a revenue shortfall of $323 million. Leaders in Maryland and DC are being forced to make some of the same Solomon’s choices we are seeing in Virginia.

In DC, approximately $60 million in cuts are likely to come in programs for children, youth, and families. One area of particular concern right now is the cuts in out-of-school-time (OST) programs. These programs are funded by the Children and Youth Investment Trust and DC Public Schools (DCPS). This year, the trust’s funding for these programs has already sustained a cut of more than 20 percent and more cuts are possible. In addition, it is highly likely that DCPS’s direct funding for OST will be eliminated, given that after school programs are not deemed essential services by DCPS.

Situation Analysis: The Demand Side
Even before September 11, the need for the services that community organizations provide was growing fast. Since the attacks and with the continued economic downturn, the need has only increased.

In the immediate aftermath of the attacks, the demand for counseling in schools and other settings spiked, but the attacks also created other, less predictable needs. One local service organization was swamped with requests from federal employees desperate to find new child care because they felt that child care centers in federal buildings are no longer safe. In addition, service organizations predict that layoffs, which have grown in number and impact, combined with the anxiety of continued terrorist threats, will increase drug and alcohol abuse, which in turn will spark increases in domestic violence and other crimes.

Nationwide, approximately 1.1 million people have lost their jobs and more than half a million people have lost their health coverage since the attacks. The US Conference of Mayors reported that requests for emergency shelter were up across the country during the winter months. According to The New York Times, this countrywide surge in homelessness was result of a unique confluence of factors: “Housing prices, which soared in the expansion of the 1990s, have not gone down, even though the economy has tumbled. A stream of layoffs has newly unemployed people taking low-wage jobs that might have otherwise gone to the poor. Benefits for welfare recipients are expiring under government-imposed deadlines.”

The same California study of 412 safety-net nonprofits that found major revenue shortfalls also found that demand for food bank and meal services has jumped 40 percent, emergency housing demand has increased 20 percent, and the need for mental health care and primary medical care has risen 19 percent.

Locally, the situation is less severe but still dangerous. According to the US Department of Labor, the DC region lost about 21,000 jobs in 2001, the first calendar year since 1991 in which there was a decline. In the previous three years, the region added an average of 95,000 jobs a year. Approximately half of these people were left without a health safety net. Even though recent estimates by Stephen S. Fuller, a regional economist at George Mason University, suggest that the National Capital Region year will show a net increase of 9,000 jobs this year, the downturn will continue to have a dampening effect on our regional economy in terms of consumer spending and the types of jobs being created.

It is worth noting that recently released US Census data have made it abundantly clear that even before September 11, poverty was more severe than we had previously acknowledged. The 2000 Census revealed that poverty rose in most District neighborhoods during the 1990s, even as the rising tide was lifting a great many boats in other areas. (It is safe to assume that similar poverty patterns would be seen in other parts of the National Capital Region, as extreme poverty is not unique to the District.) According to The Washington Post, “The nature of poverty changed: The number of people who are severely poor—with incomes that are half the federal poverty line—rose sharply. Poverty among the city’s children also is growing, now reaching one in three.”

Possible Response Scenarios
There are several different ways in which nonprofits, funders, and governments could respond to the restriction of supply and surge in demand outlined above. One realistic but undesirable possibility is that the new pressures result in little behavior and policy change. Under this status quo scenario, the funding situation for nonprofits remains gloomy for years. State and federal legislators, under pressure to hold the line on visible and popular programs, cut back on social-service programs that benefit those who have little voice and political clout. Individual, foundation, and corporate donors continue with their current funding approaches—but on a significantly smaller, less-ambitious scale. More community and family needs go unmet. Recent positive trends in crime, drug abuse, teen pregnancy, and welfare dependency begin to reverse. America’s underclass grows.

A far more positive response, which could be called the “tipping point” scenario, involves significant behavior change by all major stakeholders. Under this scenario, there is a recognition that September 11 and the ensuing economic decline are serious wake-up calls with lasting implications. Coupled with this recognition is a serious desire to engage in a soul-searching examination of ways our society could better support the work and expand the impact of nonprofit organizations.

The “tipping point” scenario involves two major pushes. First, public and private funders collaborate with nonprofits to increase the effectiveness of nonprofit sector. Because of increasing resource constraints, grantmakers and grantees become more strategic in their decisions, recognizing that not all causes are created equal and not all organizations are equally capable of achieving a significant positive impact in their communities. These funders become even more concerned about concentrating resources on the areas with the greatest potential for social impact (e.g., early-childhood education). They increase their focus on scale, consolidation, and collaboration to spread good models and minimize the all-too-common exercise of reinventing wheels. They work together to strengthen not only programs but also the organizations behind the programs. They establish and track outcomes and use this information as a basis for assessing and improving their work.

Second, because increased effectiveness alone cannot resolve the long-term challenges for the nonprofit sector, private funders assume larger role and speak up with a louder voice in public policy debates. The goal of this advocacy is to rectify the extreme undercapitalization of quality nonprofit work. For example, large coalitions of funders and nonprofits advocate for suspending or revoking some of the most expensive provisions of 2000 tax cut (the tax cut is a much greater drain on the US Treasury than are the new demands of homeland defense) and other major changes in public policy that could increase long-term resources for community-based nonprofits. In addition, it may make sense to revisit the controversial option applying the concept of “sin taxes” to the industries sure to benefit from war-related spending, as a means to create new revenue sources to help fund the growing needs of our communities.

The Implications for Venture Philanthropy Partners
The role and importance of groups like Venture Philanthropy Partners that offer serious philanthropic funding to strengthen organizations is more important than we could have imagined when we began this effort. Yet there is no question that the “perfect storm” described in this paper could well undermine the growth of our community partners, as well as their ability to maintain their current levels of service.

These are the moments when groups of like-minded citizens need to discuss actions beyond serious correspondence over serious issues. We and others need to decide how far we should go in pressing what we believe are crucial civic interests. How do we operate within democratic rules to act on our convictions when we believe the consequences will be deeply hurtful if we don’t? How do we engage in this conversation among ourselves? What role do the young people themselves have in pressuring for change? Within proper legal limits, how far should we go down the path of advocacy? Do we engage in direct lobbying? Litigation?

The founding concept of VPP was bringing together people who wanted to do more than write a check and leave the work to others. It has been successful in going beyond the dollar signs. Is it time for VPP to think about its strategy more expansively, in order to perhaps land upon a wider repertoire of effective actions?