The New ‘Nonprofit Killer’ Bill and the Problem of Government Certification

The US House of Representatives just passed H.R. 9495, the Stop Terror-Financing and Tax Penalties on American Hostages Act.

As with most federal bills, the name is pretty sympathetic. Who doesn’t want to stop the funding of terrorism? It also contains two related, but very different, proposals.

According to Congress’s official website:

This bill postpones certain tax filing deadlines for U.S. nationals who are unlawfully or wrongfully detained abroad or held hostage abroad and their spouses. It also allows for a refund and abatement of tax penalties and fines paid by hostages, detained individuals, and their spouses or dependents.

The bill terminates the tax-exempt status of terrorist supporting organizations.

Interesting what a pivot we take in the last sentence there. The first part of the bill seems like a great idea. It’s shocking that our system doesn’t already have a mechanism for waiving late tax payments for people held hostage by terrorists.

But then, we tack on one more thing—no more tax-exempt status of terrorist-supporting organizations. This part of the bill has earned it a nickname: the “nonprofit killer.”

This seems like two totally different things attached by a staple. This is likely intentional and is a classic strategy in modern American politics. By lumping these two things together, representatives can use the hostage income tax abatement part of the bill to explain why they voted for it.

One way to think about this is that supporters of the second part of the bill are getting politicians who are on the bubble to vote for the bill by giving them something they like in return (the hostage tax abatement). Economists call this logrolling.

But what about the second part of the bill? What’s controversial about removing tax-exempt status from organizations that support terrorism?

Taxing Terror?
The problem with this bill is that it is a perfect example of giving undue discretion to bureaucrats. That’s an issue, because government agents are often far less angelic than we’d like them to be.

David Hume once summarized the state of political philosophy by saying that from the perspective of political analysis, “every man ought to be supposed a knave, and to have no other end, in all his actions, than private interest.”

In other words, we should assume that people are narrowly selfish and not beneficent, and we should build a political system based on those assumptions.

Why be so pessimistic? Well, if we make a system that assumes everyone will be a knave, we can withstand it when knaves rise to power. If we make a system that assumes that our leaders are omnibenevolent geniuses, the system is likely to fall apart.

So, what would knaves do if we passed a bill removing tax-exempt status from organizations that support terrorists? I think they would use this legislation as a way to target their ideological enemies. Specifically, they would accuse organizations they don’t like of supporting terrorism in an attempt to get the tax-exempt status of those organizations removed.

It wasn’t long ago that candidate Trump faced an onslaught of accusations that he had enabled or even promoted domestic terrorism in the 2020 transition. Had HR 9495 been the law of the land during the campaign, it’s not hard to imagine his opposition targeting the nonprofit status of Trump-supporting organizations, including PACs, using this law.

If this sounds far-fetched, it shouldn’t. Recent history vindicates this fear. FEMA recently got in hot water when it was uncovered that some of their agents intentionally avoided providing relief to the residents of homes displaying pro-Trump campaign signs.

Some might argue that this was just a rogue employee, but there are two issues with this. First, what’s to stop a rogue employee of another government agency from targeting Trump organizations with this bill? Second, it’s still unclear to what extent this problem was systemic.

We even have precedent that the IRS abuses its power in a politically partisan way. During the Obama administration, Tea Party-linked organizations were excessively scrutinized, and the IRS has since apologized for these decisions.

This issue is particularly salient with respect to foreign policy. Foreign policy hawks often slander supporters of peace with claims that they sympathize with the other side. How can we trust politicians to apply these standards fairly when major party representatives like Hillary Clinton suggest that US veteran and politician Tulsi Gabbard is a Russian agent?

Gatekeepers of Legitimacy
This leaves us with a tough question: Does this mean we can’t do anything to combat bad organizations? No. Individuals can still exercise moral responsibility and withhold their funds from unethical organizations, regardless of what the rules are for 501(c)3.

However, a problem arises when the government gets into the sphere of determining which organizations are worthy of being tax-free. When we allow that to happen, we implicitly accept that they are the rightful gatekeepers of legitimacy.

But this point raises an even more fundamental conversation: Why do we need to grant organizations special tax-exempt status from the top down at all? Why tax organizations?

In reality, it’s impossible for a tax burden to fall on an abstract entity like a business or organization. At the end of the day, every tax is paid for by people. When the government taxes businesses and organizations, they are essentially engaging in what’s called double taxation. The income for the organization is taxed, but, then, the remaining money is distributed among the workers, owners, and suppliers, and this income is also taxed.

In theory, tax rates on individuals could be adjusted such that no organization is taxed but individuals end up with the same amount of money as they would have had under the current double taxation setup. Why do things this way then? Why tax people through something called an organization?

The cynical answer is that it’s easier politically for politicians to tax organizations, because people are less likely to sympathize with organizations than with people. Have you ever met a rich corporation? Is the rich corporation in the room with us right now? It would be less popular for politicians to say, “We’re going to tax your 401k if you hold stock in big corporations,” or, “We’re going to increase the taxes of workers in this big corporation.”

You can make an argument that certain organizational efficiencies may make the organization itself technically more efficient at handling these tax burdens, for example, so there are some good arguments for this mechanism.

However, it’s important to recognize the downside of our current system. When organizations are taxed and the government gets to decide which ones get tax-exempt status, politicians have an incentive to modify rules to damage organizations which harm their interests. H.R. 9495, if it passes the Senate, stands to make this problem a lot worse.

This piece originally was published by the Foundation for Economic Education.