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Not-for-profit Regulation: The Challenge of Striking a Balance

Published: May 10, 2011 in Knowledge@Australian School of Business
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Australian Prime Minister Julia Gillard has formally recognised Australia's A$50 billion not-for-profit (NFP) sector with an office in her department dedicated to creating the Australian Charities and Not-for-profit Commission, the one-stop regulator for nonprofit organisations formally announced in the 2011 federal budget. In December 2010, she appointed the Not-for-profit Sector Reform Council to advise on the best form of a single regulator for the not-for-profit sector of the economy, with the aim of elevating the role of non-profit organisations beside government and business.

The reform council was handed the opportunity to take a clean sheet of paper and draw up a regulatory framework that anticipates an even greater role for non-profit organisations in Australia's future development. It's part of a wave of international interest in building up the not-for-profit or "third sector" of the economy. Australia is playing catch-up as it comes a decade after former UK Prime Minister Tony Blair's government established the Office of the Third Sector to promote a radical third way to solve difficult social problems by harnessing community groups in collaborative and entrepreneurial ventures.

The idea of grouping organisations that were not the state or the market into a "third" or "non-profit sector" is relatively new. It arose in the mid-1960s when US economists were invited to consider the effect of the 1969 Tax Act reforms on philanthropy and identified the defining question as how non-government organisations distributed their profits.

According to Hungarian economist Mihaly Hogye, the existence of the non-profit sector is a response by unsatisfied customers to the failures of the market and the government. The size of the non-profit sector is determined by the number – or proportion – of customers whose demands the market and government are unable to fulfil. Contract failure theory explains how non-profits compete efficiently in a marketplace where trust is important, says Hogye. An important objective of NFPs is to ensure customer control over producers and service providers when monopoly markets fail.

In Australia, a breakthrough came in 2000 when the Australian Bureau of Statistics (ABS) reported on the not-for-profit sector and helped to give it an identity. Now the sector is emerging from the shadows and is increasingly being recognised for its contributions to both society and the economy, in particular in health, education and community services. The federal government sees it as a partner delivering services and filling gaps in its programs and says a strong relationship is crucial to the success of its social inclusion agenda. Non-profit organisations are prominent in raising awareness of social and environmental issues, and addressing social disadvantage. ABS surveys show that NFPs are generally viewed as more trustworthy than government or business.

British Prime Minister David Cameron is keeping up the UK's momentum for creative public-private partnerships to promote the public good and has denied the initiatives are a mask for cuts or outsourcing to save money. His cash-strapped government has given bipartisan support to "open up public services to new providers like charities, social enterprises and private companies so we get more innovation, diversity and responsiveness to public need". An example is the entrepreneurial organisation New Philanthropy Capital, set up in 2002 by investment banking staff at Goldman Sachs as they tried to identify the best way to give money to charity. They recognised a dearth of information and advice for potential donors and filled the gap with a marketplace linking charities and funders.

In the same spirit, The Centre for Social Impact (CSI) at the University of New South Wales (NSW) joined last month with the NSW Government to pilot a social impact bond– a financial instrument that pays a return to investors based on achievement of agreed social outcomes – to be used on early intervention programs in areas such as juvenile justice, mental health and services assisting young families at risk.

In the US, President Barack Obama put up US$50 million seed money in 2009 for a Social Innovation Fund that hopes to attract another US$150 million from philanthropists for "intermediaries" to encourage innovative non-profit groups in areas where welfare is making slow progress and the President has recently asked Congress to allocate US$100 million to test the application of social impact bonds.

Implementation Time

Yet, internationally, the enthusiasm for social entrepreneurship has run ahead of its effects, according to a sober assessment in The Economist magazine. "Successful innovations have spread only slowly, if at all." Australia has some runs on the board, but the government still lacks a coherent policy framework for the Third Sector. This is despite a string of inquiries over the past 15 years. Australia's Minister for Social Inclusion, Tanya Plibersek, says the non-profit sector has been widely consulted and it's now time for implementation via the reform council. 

The government is establishing the new commission, which was formally announced in the Budget and is expected to begin operating in July 2012, to deliver improved transparency and accountability for the third sector. Fulfilling an election promise, in January this year the government issued a scoping study that sought comment from stakeholders on the goals, scope, functions and form of a national regulator. This was based on a 2010 Productivity Commission (PC) inquiry and previous studies.

The stakes are high, involving 600,000 diverse organisations – although less than 60,000 are economically significant – from sports clubs to private schools, hospitals or welfare groups, multinational charities, business associations, churches, environmental or any other group that does not distribute profits to members.

Exactly how a national regulator for such groups will operate in 2011 is up for grabs. CSI's Andreas Ortmann, professor of Experimental and Behavioural Economics at the Australian School of Business, agrees with the Productivity Commission's analysis of the problem. "Given the sector's tremendous importance in revenues, volunteered contributions, and employment – and in its impact on the social fabric of Australian society – the lack of reasonable standards of accountability and transparency in the use of public and private funds is troubling and in dire need of fixing." Yet Ortmann cautions against following outdated Anglo American regulatory frameworks and recommends fresh approaches including use of fundraising certification agencies such as those in Germany and the Netherlands.

Australia has the challenge of drawing up a regulatory system for the 21st century, believes CSI head of research Les Hems. "A new approach is needed for the Internet age," he says. "[We need to use] web technology to construct a portal that exploits data across a distributed network of existing regulatory agencies such as tax, state licensing and consumer protection functions. The portal should hold a full list of not-for-profits – the spine for a network of other functions so responsibility is distributed and not centralised with an emphasis on self-reporting and self-regulation. It needs to be proportional with a high level of functionality for large and service providing not-for-profits but light touch for the tens of thousands of small volunteer run organisations. It also needs to acknowledge and accommodate the emergence of hybrid organisational forms including social enterprises."

Economists should be involved because they understand that regulation is about risk and incentives, says Hems. "You also want visible incentives – so the NFPs can be seen to be performing well. They might have a licence and meet a quality standard, such as the standard required by the National Childcare Accreditation Council. We now behave very differently as consumers and use web technology to check things out. If you give money to charity and do not get the promised newsletter, you give a thumbs down on the website. It's a small way for a citizen to hold organisations to account. But you can display how an organisation has delivered on its promises. It encourages self-regulation."

Five previous reports on NFPs produced a lot of recommendations, but little in the way of implementation, notes Linda Lavarch, former Queensland attorney-general and academic, who now chairs the NFP Sector Reform Council. Meeting for the first time in March this year, the council has its work cut out. "The sector is very diverse – a lot of issues and a whole lot of areas have been left untouched for a long time," says Lavarch. The government appointed the reform council, comprising people who have a good relationship with the NFP sector, to give strategic advice on implementing the recommendations from last year's Productivity Commission report. "For instance, whether there should be a NFP regulator with a big stick, and what its role should be?" Lavarch explains. "The scoping paper thinks it should be a centralised role, a coordinating role instead of filling in forms and being the place where charities get a gaming licence. Until now charities have been regulated at state level under the Corporations Acts or at the corporate level by ASIC. A guiding principle is reducing red tape. The question is where you strike the balance."

There is the option of direct regulation and indirect regulation, Lavarch points out. "(The new commission) could deal with applications for tax concessions for charities that fundraise – and so act as a gateway to concessions, deciding who's in and who's out. As a national and independent regulator, it will give a face to the sector [just] as Tony Blair's Office of the Third Sector gave it a distinct identity."

The Definition Dilemma

Lavarch observes that Australians are familiar with the parts – community welfare services, the environment movement, housing initiatives – rather than the whole third sector. "The commission will give the sector a united front",she says. "Given budget restraints, I think it could quite effectively operate as a small independent commission. The UK's office is a big operation that is now copping some service cuts. I think a possible model is Singapore comprising a government charities unit and a charity council that promotes self regulation. What the government wants it to be is more than a regulator, it wants the regulator to promote the sector and facilitate its growth, strengthen it."

In Australia, there's no strict definition of what a charity is. "There was an inquiry in the 1990s but the states and the Tax Office kept the Elizabethan statute which sets out what is a charitable purpose," Lavarch says. "The Howard government tried to legislate on a definition but it did not pass because it was too narrow with more losers than winners. There was another side of the issue. The Howard government had service agreements with charities which involved gag clauses preventing them speaking out in public. Charities had to be careful what they said for fear of losing funding. That definition prohibited advocacy for charitable purposes. So AID/WATCH was refused tax exemption, but the High Court found in its favour, that advocacy was part of their charitable works relieving poverty and education."

Despite the extensive reach of not-for-profit organisations, the level of understanding among the wider community of the sector's role and contribution is poor and deserves attention. A nationally agreed measurement and evaluation framework would add significantly to this understanding, according to the Productivity Commission's report last year.

"Current information requirements imposed on NFPs for funding and evaluation purposes are poorly designed and unduly burdensome," the report said. "Reform is needed to meet 'best practice' principles. The current regulatory framework for the sector is complex, lacks coherence, sufficient transparency, and is costly to NFPs." The inquiries are clear about what reforms are desirable, but not on what shape the proposed regulator should take to be able to achieve this. Hems says the scoping study plunged into the detail and complexities of NFPs, instead of first deciding why regulation is needed, how to best regulate them and then determining a form for that regulation.

While the details of the new Australian Charities and Not-for-profits Commission (ACNC) – which is budgeted to cost A$53.6 million over four years – are yet to be examined, assistant treasurer Bill Shorten says it will improve the red tape that not-for-profits currently have to deal with. It will also provide education and support to charities and determine applications for not-for-profit status, a role that has been undertaken by the Australian Taxation Office.

The scoping study suggested the form of the proposed national regulator could be similar to the New Zealand Charities Commission. The New Zealand regulator's role is to process applications for registration as charitable entities and monitor qualifications; educate charities about matters of good governance and management; compile a public register of charities; receive returns; supply tax information (although the NZ Inland Revenue actually administers charitable tax exemptions); investigate breaches and conduct research.

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