Conferences / Philanthropy and the State

The Changing Role of Foundations in Regulatory Reform: The Case of Small-Dollar Loan Reform

Editors’ Note: In early June, the Policy History Conference in Nashville held a panel on “Private Foundations and Public Policy.” In this post, one of the panelists, Anne Fleming, shares some of the research she presented, continuing HistPhil’s forum on Philanthropy and the State.

The work of the modern foundation in policymaking often takes a familiar form: funding policy-relevant social science research. In the present day, for instance, the Pew Charitable Trusts have played a significant role in the current debate over how to regulate payday loans, by contributing research on how and why households use payday loans and putting forth general policy recommendations based on this research.[i] Looking further back in time, the Russell Sage Foundation played a similar role in an earlier generation’s policy debates over small-dollar loans. Beginning at its founding in 1907, the Sage Foundation undertook the study of the small-dollar lending industry as part of its broader mission for “the improvement of the social and living conditions in the United States of America.” Like Pew, the Sage Foundation sponsored a program of social science research on the small loan business, orchestrated by its Division of Remedial Loans, along with similar research in other fields. As historian Alice O’Connor has observed, the Sage Foundation’s work in this era was “politically engaged” and rooted in a “reformist vision of social science.”[ii]

But there is a crucial distinction between the work of the Sage Foundation and the modern Pew Charitable Trusts in relation to small-dollar loans: the Sage Foundation went beyond merely funding social science research. It also drafted model state lending legislation, in consultation with lending industry leaders, and lobbied for its adoption on a state-by-state basis in the late 1910s and 20s. As one Sage official explained, the Foundation decided that a “legislative remedy lies not in the passage of further restrictive laws but in the enactment of measures allowing a sufficient rate of interest to attract the capital of reputable men to the business.”[iii] Accordingly, the law it devised, known as the Uniform Small Loan Law, created an exemption for licensed small-sum lenders from otherwise-applicable state interest rate ceilings, allowing them to charge a higher rate of up to 3.5% per month. It was difficult to convince skeptical state lawmakers that increasing the legal rate would benefit poor wage earners, so the Sage Foundation’s active support for the bill was critical to ensuring its passage. And by most accounts, the Foundation’s campaign was a success; at least twenty-five states had enacted some version of the Uniform Law by 1930. Indeed, in light of this success, some contemporary scholars have lauded the Foundation’s work as a model for reforming the modern-day small-sum lending industry.[iv]

The Foundation abandoned active legislative work around 1934, however. According to one history, there was a “pronounced” change in the focus of the lending division’s work in 1934. In brief, “[l]egislative work in the small loan field was minimized and research was emphasized.”[v] Thereafter, the Foundation continued to work on the small-sum lending problem, but its efforts took the form of funding social science research, rather than legislative advocacy. This shift occurred over a decade before the Foundation’s more well-known reorganization in the late 1940s, when it came to embrace a “neutral, politically detached” social science and fell back from the front lines of social reform to the “second trench.”[vi] This earlier shift begs the question: what happened in 1934, and might this help explain why no contemporary philanthropic group has heeded the call to draft and lobby for a new small loan law?

Although multiple forces were surely at work in shifting the Sage Foundation’s approach away from active legislative work, including those behind its later 1940s reorganization, the Revenue Act of 1934 is a factor that has not received much scholarly attention. The 1934 Act instituted a major change in the federal tax treatment of foundations by setting new limits on lobbying by “charitable” organizations. It provided that an organization did not qualify for the tax benefits available to “charitable” foundations if it engaged in substantial political activities. Under the new rules, a charitable corporation or foundation was exempt from federal income taxation only if “no substantial part” of its “activities” involved “carrying on propaganda, or otherwise attempting, to influence legislation.”[vii] In contrast, prior to 1934, corporations “organized and conducted solely for charitable, religious or educational purposes” were exempt from taxation, but the tax code did not define “charitable” to exclude those engaged in substantial “legislative activity.”[viii]

In internal correspondence, Sage Foundation officials noted this change in the tax rules, which meant that the Foundation could not continue lobbying for the Uniform Law if it wished to retain the tax advantages accorded to charitable organizations. The state would no longer provide public funds (in the form of tax breaks) to support philanthropists’ efforts to influence public policy directly through legislative lobbying. It would, however, support philanthropy’s production of what Alice O’Connor calls “social science knowledge.” Thus, the Revenue Act of 1934 encouraged the Sage Foundation to begin its retreat to the “second trench” of policymaking well before the late 1940s.

It also erected a significant barrier to any private foundation mounting a similar small-dollar lending law reform campaign in the future. Today, Pew can engage in limited legislative advocacy only because it took the unusual step of reorganizing from a private foundation to a “public charity” in 2004, allowing it to spend up to five percent of its annual budget on lobbying. Most private foundations are ineligible for “public charity” status, however. Federal tax rules still effectively prohibit a private foundation like Russell Sage, which is endowed by a single donor rather than supported through multiple sources, from launching a new campaign for a small loan law or engaging in other lobbying activities. The endurance of this prohibition on lobbying is important not only because it continues to direct the policy work of the philanthropic sector towards funding policy-relevant research. It also suggests that Americans remain wary of granting foundations an unrestricted role in public governance and continue to be mindful of the dangers that great concentrations of wealth may pose to a thriving democracy.

-Anne Fleming

Anne Fleming is an Associate Professor of Law at the Georgetown University Law Center.  Her forthcoming book explores the growth and regulation of the small-sum lending industry in the United States over the course of the twentieth century.  She holds a JD from Harvard Law School, and a PhD in History from the University of Pennsylvania.

NOTES:

[i] http://www.pewtrusts.org/en/projects/small-dollar-loans-research-project

[ii] Alice O’Connor, Social Science for What ?: Philanthropy and the Social Question in a World Turned Rightside Up (New York: Russell Sage Foundation, 2007), 5, 26.

[iii] Anne Fleming, “The Borrower’s Tale: A History of Poor Debtors in Lochner Era New York City,” Law and History Review 30, no. 4 (2012): 1057.

[iv] Ronald Mann, “After the Great Recession: Regulating Financial Services for Low- and Middle-Income Communities,” Washington and Lee Law Review 69, no. 2 (2012): 749.

[v] John M. Glenn, Lilian Brandt, and F. Emerson Andrews, Russell Sage Foundation, 1907-1946 (New York: Russell Sage Foundation, 1947), 531.

[vi] O’Connor, Social Science for What ?, 48; Stanton Wheeler, “The Commitment to Social Science: A Case Study of Organizational Innovation,” in Social Science in the Making: Essays on the Russell Sage Foundation, 1907-1972, ed. David C. Hammack and Stanton Wheeler (New York: The Foundation, 1994), 132.

[vii] Revenue Act of 1934, Section 101, 48 Stat. 680.

[viii] Tariff Act of 1894, Chapter 349, section 32, 28 Stat. 556; Oliver A. Houck, “On the Limits of Charity: Lobbying, Litigation, and Electoral Politics by Charitable Organizations under the Internal Revenue Code and Related Laws,” Brooklyn Law Review 69 (2003): 9–12.

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