Although nonprofit organizations are generally exempt from income taxation, they pay taxes on profits from activities unrelated to their primary exempt purpose. Congress intended this tax on unrelated business activities to prevent unfair competition with for-profit businesses and to raise revenue. In the aggregate, nonprofits report annual losses on their taxable activities of more than $1 billion on $4 billion of revenues. In contrast, they report aggregate profits of over $50 billion on their tax-exempt activities. Analysis of a database of confidential tax returns suggests that medical and educational nonprofits allocate expenses from their tax-exempt to their taxable activities to reduce their tax liabilities, although unfortunately it is not possible to determine the extent to which these allocations represent noncompliance with tax laws. In contrast, I find no evidence that charitable nonprofits engage in tax-motivated allocation behavior.

We examine how taxes affect donations given to nonprofit organizations and how this varies across nonprofit types. Most prior studies constrained tax price elasticities to be constant across nonprofits, primarily because the data do not provide donations by nonprofit type. Using nonprofit-level data and average marginal tax rates that vary across years and states, we estimate tax price elasticities by nonprofit type. We find an aggregate public charity elasticity of approximately −1.0 and a private foundation elasticity of approximately −2.0. These results suggest that the cost of the charitable contribution deduction is roughly proportional to its benefit for public charities, but that the deduction stimulates significant giving for private foundations. When we partition our elasticities across 24 public charity types, we find significant elasticities of −1.0 or larger for six types. This result suggests that the effect of the charitable contribution deduction varies significantly across nonprofit types.

Prior research finds that donors reward nonprofits that report larger program ratios with more donations and that program ratios frequently are subject to intentional manipulation as well as unintentional errors. We examine how donors react to low-quality ratios. We find that the average donor discounts ratios that are inflated by only the simplest and most observable of methods. We then examine the effect of financial data availability on the average donor's ability to unravel inflated ratios by using the historical shift in data availability that occurred in 1997 and 1998. We find that donors began to discount ratios only after 1998. Finally, we examine whether the discount applied to program ratios varies across donor sophistication (measured as the percentage of fund balances with restrictions) and find that sophisticated donors apply incrementally larger discounts to inflated ratios and discount ratios that are inflated by more complex methods.

We examine whether nonprofit organizations understate fundraising expenses in their publicly available financial statements. A large body of anecdotal evidence notes that an inexplicable number of nonprofits report zero fundraising expenses. We provide empirical evidence that the zero fundraising expense phenomenon is at least partly due to inappropriate reporting. We then examine to what extent these misreported expenses are the result of managerial incentives. Prior research finds an association between reported expenses and managerial compensation as well as the level of donations received. Using these findings we construct two incentive variables and find a positive association between misreporting behavior and managerial incentives. Our results also suggest that the use of an outside accountant reduces the probability that a nonprofit will misreport expenses, consistent with the use of an outside paid accountant increasing the reliability and usefulness of nonprofit financial reports. Finally, we find that SOP 98-2 reduced the probability that a nonprofit will misreport fundraising expenses.