Nonprofit organizations frequently use tax-exempt borrowing, and the importance of such borrowing to the sector has only grown over time. The Joint Committee on Taxation estimates that the tax-exemption on bonds issued by nonprofit hospitals and educational institutions alone costs the US Treasury more than $5 billion annually in reduced individual and corporate income taxes (Sherlock and Gravelle 2009). While the Tax Reform Act of 1986 limited the use of tax-exempt borrowing by nonprofits, changes to the law in 1997 removed formal restrictions on the amount of tax-exempt debt issuable by nonprofits.

Despite the importance of tax-exempt debt to the financing needs and capital structure of nonprofit organizations, we know surprisingly little about how nonprofits use tax-exempt debt. The limited treatments of the subject have generally focused on hospitals (for example, Gentry 2002, Wedig et al. 1996, and the CBO 2006) – which are generally not representative of the entire nonprofit sector due to the size, sophistication, and commercial nature of operations. Other nonprofit organizations have generally been overlooked by the literature, as has the fact that access to the tax-exempt debt market is gained through government conduit or “on behalf of” public authorities. Recently, smaller nonprofit organizations have begun to increase their use of tax-exempt debt (Smith 2006), suggesting that understanding this practice is increasingly important. Further, as the federal government deals with significant resource constraints, tax exemptions to nonprofit organizations are likely to come under scrutiny.

Implicit throughout the literature examining the public-nonprofit relationship (see, for example, Young 2006) is the notion that government support to nonprofits comes in the form of current financial resources made available for current charitable services. Yet many nonprofits require significant capital assets to provide such goods to the public: hospitals require significant buildings and equipment, universities require classrooms and dormitories, and community development corporations require property and buildings. Access to the tax-exempt debt market is a less visible source of government support for nonprofits. Such debt tends to have lower costs and better terms than taxable debt.

In this paper, we build from Denison’s broader examination of nonprofit borrowing (2009) and use IRS data from 1998 through 2009 to analyze which nonprofit organizations use tax-exempt debt, and – because of the need to issue through conduits – how tax-exempt debt issuance by nonprofit organizations differs across the states based on variation in state institutions. We purposely use two different data sets to ensure our sample and analyses include a wide range of nonprofit users of tax-exempt debt. We then turn to analyzing the relationships between tax-exempt borrowing by nonprofit organizations and their financial activities – including changes in charitable activities, unrelated business activities, and the retention of bond proceeds for arbitrage purposes.