Dean Karlan, professor of economics at Yale University, recently wrote an article about determining if a charity is wasting donated money on overhead expenses. In this article, he discusses the “overhead ratio,” which we have discussed in a previous article. Karlan discusses the annual tax returns nonprofit organizations must file each year, and how most people use these public documents as guidance on which nonprofits will use their donated dollars in the best possible way. “[The tax returns] are useful for weeding out potentially fraudulent charities, but nothing more” states Karlan.
Karlan analyzed tax returns of nonprofits that make more than $1 million, which add up to nearly 55,000 organizations. Of those organizations, only 2.5% of them have an overhead ratio of more than 50%. The other 97.5% spend more on actual work than on administrative costs. His research also concludes that only 1% of total contributions by the public were lost by giving to “bad” charities. He states that simply because an organization does not spend a high percentage on overhead does not mean that a charity is effectively using its resources. What really matters, according to Karlan, is determining “how effective a particular program is in actually helping people.”
Deeper into the article, Karlan drives home the point of why overhead expenses are necessary and useful to a nonprofit’s effectiveness: “If overhead spending is cut too much, it may make a charity less effective if the capacity to recruit talent or make evidence-based decisions has been compromised.” When choosing charities and organizations to contribute to, Karlan’s advice is to set the bar for administrative costs at around 30% of a nonprofit’s overall budget and also look for evidence of the impact an organization’s programs have.
To read Dean Karlan’s original article from the LA Times, click here.
In a statement made last summer about the overhead ratio, GuideStar CEO Jacob Harold, along with CEOs of Charity Navigator and BBB Wise Giving Alliance released a co-signed letter stating that the “overhead ratio is the wrong measure to consider when determining if the nonprofit is effective or efficient.” Just last month, we featured Harold in an article about the “overhead myth.” Be sure to check it out here for more information on the subject.