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Jul 1, 2011

State Watch: How Budget Cuts Affect Nonprofits

Many nonprofits have felt the tight pinch from state budget cuts and may have done too much to mask their impact. In a recent blog, I noted that nonprofits will face some choices they have tried hard to avoid: telling the government they cannot sign those contracts on the terms the government is offering, and then turning around and telling their clients that their services are ending. A hard reality will soon be confronting the nonprofit world and those who believe deficit reduction will not affect them and their neighbors.

Let me expand.  State, federal, and local governments have been talking budget cuts for years.  Sometimes they have cut, and sometimes they have not.  Most taxpayers haven’t noticed much impact on their lives.  They just see four words:  debt, deficits, tax increases.  Sounds pretty simple, who wouldn’t want to eliminate or avoid all of them?  Eliminate debt:  good for country, no impact on me.  Eliminate deficits:  good for country, no impact on me.  Tax increases:  unnecessary to solve debt or deficit, not good for me.

Why is this myth so popularly accepted and expansively broadcast by a wide swath of the political world?  I think the answer is the nonprofit sector.  By their devotion to helping serve community need no matter what, they have left many of us with the impression that government budget cuts will not impact us.  They have done this by being the buffer between government cutbacks and our perception of public services.

First, a couple of facts from my earlier blogs: The Urban Institute surveyed human services nonprofits and connected with over 32,000 that have government contracts to provide governmental services.  Three-fourths have multiple contracts with the government.  Yes, that is the result of the outsourcing movement of the 1980s and 1990s.  Hold down unpopular government payroll by shifting service provision to the nonprofit sector.

Second, the government has been solving its budget problems by out-Walmart-ing Walmart.  Walmart is famous for pressing the profit margins of its suppliers.  The government should be famous for eliminating the profit margins of nonprofits.  Especially state and local governments almost never pay the full cost of the services they contract for.  The Urban Institute found 68 percent of the nonprofits were paid less than the full cost of contracted services.  Even more galling, in contracts for over half of the nonprofits, the government requires the nonprofit to match the government funding of the contract or absorb a portion of the government’s cost.  AND, the government pays late.  Over half the nonprofits reported that the government pays even later than specified in the contract, typically 90 days later than contract terms.

What does that mean for nonprofits?  It means that they had to pay their bills when government payments weren’t coming in and, when they did, the payments were less than it cost the nonprofits.  First, a for-profit company would NEVER sign a government contract that didn’t cover its costs, and probably would insist on a profit.  Second, a for-profit would add a significant interest penalty for late payments.  Yet nonprofits take a hit on both.

Third, the vast majority of nonprofits have penalized themselves and their employees in order to prevent the public from seeing any service impact from the government cuts.  Half of nonprofits nationally have frozen or reduced staff salaries and over 40 percent have reduced staff benefits and drawn down reserves.  But only one-fifth made any reductions in services, and in 27 states the proportion of nonprofits who reduced services was even less.  Great – nonprofit cash and their employees’ financial welfare have paid to maintain the government services that taxpayers don’t need to pay for.

Forget the philanthropy silver bullet.  The most recent IRS Statistics of Income shows that philanthropy is only 22 percent of nonprofit revenues, and the share has not exceeded 24 percent since 1985.  The only way the next wave of government budget cuts is going to occur with no impact on government services is if nonprofits have more savings to draw down or their employees can survive with even lower salaries and benefits.  And I don’t see that happening.

In Ohio, where state and local budget cuts loom very large, the picture is even worse.  They rank eighth in the proportion of nonprofits receiving payments that are less than the cost of services, and they rank 12th in the proportion receiving those payments late.  Yet Ohio nonprofits tried harder than nonprofits in 28 states to avoid any service cuts.  They were the 11th most likely to reduce or freeze salaries, the 8th most likely to reduce benefits and the 13th most likely to reduce employees.  But they don’t have much wiggle room:  they were the 40th most likely to draw on reserves and the 22nd most likely to borrow or draw on lines of credit.  Most likely, they had no reserves left to draw upon and instead tapped lines of credit as much as they could.

So, Ohio’s nonprofits have protected its citizens from the impact of government cuts better than nonprofits in most other states.  They have cut staff salaries and benefits even after borrowing more often than nonprofits in most other states.  That well looks pretty dry.

More salary cuts or benefit cuts?  More borrowing?  Dream on Ohio taxpayers.  You have no idea how much you have been protected.  Now Ohio taxpayers may finally realize the myth of “don’t raise my taxes” and “don’t cut my services.”  Ohio’s nonprofits and their employees and donors have done their share.  When the next round of government cuts comes through, Ohio’s nonprofits will find they can ask no more of their hard-pressed employees and their bank accounts will offer little help. Lower government payments will have to be reflected in fewer services.  What will the taxpayers say when the services disappear?  It would be ironic if they blame the nonprofits for service cuts.

Why would they misdirect the blame onto nonprofits?  Because the nonprofits’ options all point to reduced nonprofit provision of services.

Option 1 – continue doing what they have been doing.  If salaries or benefits go much lower many of their employees will have to seek work elsewhere.  Losing employees, or alternatively laying them off, will have to result in reduced services.  If they don’t do either, they will operate until they can’t make payroll or pay their bills.  Going out of business is a guaranteed service reduction.  Since the nonprofit will announce these outcomes, the taxpayer will likely blame them rather than the government’s inadequate payments.

Option 2 – play hardball and refuse to sign contracts that don’t cover the full cost of providing services for the government.  This is the nightmare of all nonprofits:  “if we don’t take the contract our competitors will.”  So, survive by not taking government contracts and shift your clients to another “more caring” nonprofit, or take the contract and join the race to the bottom of Option 1.  The nonprofit will be criticized for not caring, and the government will likely join the chorus of blaming service reductions on the refusal of nonprofits to “help” the government provide services.

Option 3 – play hardball by joining together and demanding better contract terms from the government along with a clear public relations campaign that lays out the financial reality of nonprofit financial survival and putting the entire discussion into the terms that businessmen understand:  “pay less than the cost is a sure formula for bankruptcy – and nonprofits aren’t loading a profit margin on top!”  Nonprofits have never done this and they have little practice in working as organized groups.  And some may see an analogy to unionization and refuse to collaborate, blaming the collaborators for trying to better themselves at the expense of larger government deficits and leaving their clients in the lurch.

There are no good options and all have the potential for the nonprofits to take all the blame.  But moving cautiosly ahead on all options may be the best way for Americans to get realistic.

I tell nonprofits to make sure they know what their key mission service is versus their services which have other nonprofit providers.  Make the key mission the service they continue to provide through money-losing contracts and have their layoffs or wage reductions be in the other service areas – that is one step back from the brink of option 1

I tell them that one goal for each is to reject at least one money-losing contract in the next six months – that is one step ahead under option 2.

I tell them to form a local association if they don’t have one.  In Ohio I know of the Human Service Executives of Greater Cincinnati, the Franklin County Human Services Chamber, and the Columbus Cultural Leadership Consortium.  I hope there are many more.  I encourage them to share their financial challenges with each other to learn they are in the same boat.  And I encourage them to create united messaging to their elected officials that describes how much they lose on their government contracts and the impracticality of expecting philanthropy to surge to fill the gap – that is one step ahead under option 3.

Little steps on all fronts with some unsympathetic criticism.  Or ultimate failure.  In either case, the taxpayers will finally see that government deficit reduction means fewer of the services they believe is their right.