The Debate about Charity Overhead – What You Need to Know

The Debate about Charity Overhead – What You Need to Know

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The debate about charity overhead is often in the news these days. For example, the Wounded Warrior Project fired its top two CEOs last year after it deemed a million-dollar meeting was entirely too extravagant. Only a few years ago, Dan Pallotta gave his famous TED talk entitled The Way We Think About Charity Is Dead Wrong. In this speech, Pallotta argued against using overhead as a metric for judging charity efficacy. He proclaimed that some organizations were attempting to become too efficient to really do any good. While he brought up many important points and helped bring attention to a problem that was crippling many charities, the whole conversation may be oversimplified. In recent years, other voices have added significantly to the conversation.

Defining Overhead and Acceptable Limits

The debate about charity overhead comes down to the fact that no legal line exists for what people consider acceptable spending. In general, watchdog groups start to take notice when overhead accounts for more than 25 percent of total spending. The Wounded Warrior Project had exceeded 40 percent according to some estimates, although Charity Navigator puts its overhead right around 40 percent. However, according to the organization, its overhead is only 20 percent. This discrepancy points to another serious issue. How, exactly, does an organization measure overhead?

According to The Overhead Myth, a group that represents Pallotta’s viewpoint that the philanthropy industry needs to move away from overhead as a measure of efficacy, overhead includes administrative expenses related to operations and infrastructure. In general, staffing that handles human resources, accounting, information technology, and governance is part of the overhead. In addition, annual report production and management costs are classified as administrative expenses, as is fundraising capital. This capital could include anything from staff members to direct mailings, as well as events.

Getting Creative with Donation Valuations

The pressure to lower overhead costs has led to creative accounting at some charities. When they can count money toward program costs rather than overhead, organizations feel like they might appear more attractive to potential donors. For example, the Internal Revenue Service has recently cracked down on how charities value donated goods because this can increase program costs and thereby reduce overhead ratios. World Help, which provides relief services across the globe, recently underwent investigation by The Chronicle of Philanthropy for overvaluing medicines donated to other nonprofits.

Often, “program costs” is a fairly elastic title. United Service Organizations claimed to donors that 90 percent of donations go directly to support service members and their families. However, its tax forms showed only 71.5 percent of income spent on programs, with 16.8 percent spent on fundraising and 11.7 percent on management. The organization reaches its 90 percent figure by adding in nonmonetary donations, which total more than $200 million. These donations are not reported on the IRS form. The organization stated that accepting these donations frees more money for programs, so it makes sense to count them toward program spending.

The problem with this kind of reporting is that it misleads donors about how their money is actually being spent. CharityWatch calculated program expenditures at 63 percent and gave United Service Organization a C+. According to USO, people clearly care about overhead. It claims that monetary donations increase 5 to 10 percent when it includes the pie chart showing program spending at 90 percent in fundraising materials.

Using Misleading Accounting Practices

Calculation of program costs can also be inconsistent. On tax forms, organizations can include a certain portion of spending on salaries, travel, rent, and other overhead expenses as program costs. An executive director’s salary can be divided between programs, fundraising, and administration according to the amount of time spent on each function. However, the exact system of how to do the breakdown is not clearly defined, and different accountants will take different approaches.

These tactics are ultimately done to mislead donors, but this only occurs because donors continue to place emphasis on overhead expenses. Organizations like The Overhead Myth are doing important work to relieve this pressure, which would result in clearer reporting. These tactics are often linked to a fear of investing in the organization, which would increase overhead and perhaps decrease donations. However, this investment is critical for expanding the reach of programs and helping organizations operate more efficiently.

The Bottom Line about Overhead

In the end, the cycle is self-perpetuating. When charities focus on reducing overhead spending, they send a message to donors that they should also concentrate on this facet of information. In the end, philanthropists should do their own research on spending and perhaps even look at tax records to see how money is really allocated. The acceptable amount of overhead is different for each donor and each organization. After all, a nonprofit like an art museum should have a lot more overhead than a food kitchen. While overhead may be important to some donors, it should not be the only question that people ask, nor should it outweigh the actual work an organization is doing and the impact that it is making.

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