Consequently, it is erroneous to regard the charitable contribution deduction and tax exemption as anything other than a reflection of this larger doctrine. Congress is not merely “giving” eligible nonprofit organizations any “benefits”; the charitable deduction or exemption from taxation is not a “loophole,” a “preference,” or a “subsidy”—it is not really an “indirect appropriation.”59 Rather, the various Internal Revenue Code provisions that establish the tax exemption system exist as a reflection of the affirmative policy of American government to refrain from inhibiting by taxation the beneficial activities of qualified tax-exempt organizations acting in community and other public interests.60
(b) Other Rationales
There are, as noted, other rationales for tax exemption that pertain to charitable organizations. One of these, somewhat less lofty than that accorded charitable and social welfare organizations, is extended as justification for the exemption of trade associations and other forms of business leagues.61 These entities function to promote the welfare of a segment of society: the business, industrial, and professional community. An element of the philosophy supporting this type of tax exemption is that a healthy business climate advances the public welfare. The tax exemption for labor unions and other labor organizations rests upon a similar rationale.62
The tax exemption for fraternal beneficiary organizations also depends, at least in part, on this defense. A study of the insurance practices of large societies by the Department of the Treasury63 concluded that this rationale is inapplicable with respect to the insurance programs of these entities because the “provision of life insurance and other benefits is generally not considered a good or service with significant external benefits” to society. The report stated, however, that “tax exemption for these goods and services [insurance and like benefits] may be justified in order to encourage” the charitable activities conducted by these organizations. The inherent tax rationale64 “may” provide a basis for tax exemption for “certain” of these societies' services, according to the report. Further, the report observed that “[i]nsurance is not a type of product for which consumers may lack access to information on the appropriate quantity or quality that they need.” Therefore, the market failure rationale65 “may not be applicable” in this instance.
Other federal tax exemption provisions may be traced to an effort to achieve a particular objective. These provisions tend to be of more recent vintage, testimony to the fact of a more complex Internal Revenue Code. For example, specific tax exemption for veterans' organizations66 was enacted to create a category of organizations entitled to use a particular exemption from the unrelated business income tax,67 and statutory exemption for homeowners' associations68 came about because of a shift in the policy of the Internal Revenue Service (IRS) regarding the scope of tax exemption provided for social welfare organizations. The tax exemption for college and university investment vehicles was the result of Congress's effort to preserve the exempt status of a specific common investment fund in the face of an IRS determination to the contrary.69 As is so often the case with respect to the tax law generally, a particular tax exemption provision can arise as the result of case law, or to clarify it; this was the origin of statutes granting tax exemption to cooperative hospital service organizations,70 charitable risk pools,71 child care organizations,72 public safety testing entities,73 and qualified tuition programs.74
All of the foregoing rationales for tax-exempt organizations have been described in philosophical, historical, political, policy, or technical tax terms. Yet another approach to an understanding of exempt organizations can be found in economic theory.
Principles of economics are founded on the laws of supply (production) and demand (consumption). Using the foregoing analyses, exempt organizations appear to have arisen in response to the pressures of the supply side—namely, the need for the goods and services provided—and the force of pluralistic institutions and organizations in society. Others, however, view tax-exempt organizations as responses to sets of social needs that can be described in demand-side economic terms, a “positive theory of consumer demand.”75
According to the demand-side analysis, consumers in many contexts prefer to deal with nonprofit, tax-exempt, usually charitable organizations in purchasing goods and services, because the consumer knows that a nonprofit organization has a “legal commitment to devote its entire earnings to the production of services,”76 whereas for-profit organizations have a great incentive to raise prices and cut quality. Generally, it is too difficult for consumers to monitor these forces. This means that consumers have a greater basis for trusting tax-exempt organizations to provide the services—a restatement, in a way, of the fiduciary concept. Thus, the consumer, pursuant to this analysis, “needs an organization that he can trust, and the non-profit, because of the legal constraints under which it must operate, is likely to serve that function better than its for-profit counterpart.”77
This phenomenon has been described as “market failure” as far as for-profit organizations are concerned, in that, in certain circumstances, the market is unable to police the producers by means of ordinary contractual devices.78 This, in turn, has been described as “contract failure,” which occurs when consumers “may be incapable of accurately evaluating the goods promised or delivered” and “market competition may well provide insufficient discipline for a profit-seeking producer.”79 Hence, according to this theory, the consuming public selects the