(Part 2 of 2) Gradually and Then Suddenly: The Sixty-Year Crack-up of Federal Funding for Nonprofits

The Trump Administration has decimated longstanding patterns of federally-funded, nonprofit-delivered services. But the system's many and mounting contradictions made it a pushover.

White House photo by Eric Draper, Public domain, via Wikimedia Commons

In Part I of this series, we traced the accumulating and ideologically diverse criticism of federally-funded, nonprofit-delivered service provision from the mid-1960s through the mid-1990s. In Part II, we pick up the story with well-intentioned but ultimately unsuccessful efforts during the administrations of George W. Bush and Barack Obama to repair the cracks spreading throughout this hybrid system and to refurbish its legitimacy. We also reckon with recent and sharper critiques from the right and left that place the system’s democratic contradictions in stark relief. Viewed in the harsh but not unfair spotlights cast by these critics, we can better see how Donald Trump’s second administration has managed to topple a system that, for all of its shortcomings, had persisted for six decades. Whether we can reimagine and transform it remains to be seen. But there is no going back to the way things were.

The Rise and Fall of Compassionate Conservatism

During the 2000 campaign, George W. Bush vowed that his administration would combine compassion and conservatism to better realize the promise of both. As he put it in his stump speech, “it is compassionate to actively help our fellow citizens in need. It is conservative to insist on responsibility and results. And with this hopeful approach, we will make a real difference in people's lives."

Bush’s aspiration informed several landmark and bipartisan achievements of his presidency including, e.g., the No Child Left Behind Act. That said, at the outset of his presidency, revitalizing the federally-funded, nonprofit-delivered system of service delivery was the primary aim of Bush’s compassionate conservatism.

The theory of this case was most cogently developed and initially operationalized for Bush by John J. DiIulio, Jr., a scholar of public administration at the University of Pennsylvania. As DiIulio put it in a 1999 Weekly Standard essay entitled “The Political Theory of Compassionate Conservatism,”

“Compassionate conservatism has the makings of a coherent public philosophy, one that is entirely consonant with the Founding Fathers’ understanding of civil society and government, and with most contemporary Americans’ understanding as well.

The crux of compassionate conservatism is the will to promote active benevolence in all sectors of civil society and to institute results-driven competition within social-welfare bureaucracies, federal, state, and local. If implemented faithfully, the policies and programs that flow from compassionate conservatism might bring lasting progress against our worst social ills — notably, enormous improvements in how government helps poor children and dysfunctional families.”

This was the promise. To help realize it, the newly-elected Bush named DiIulio to serve as the inaugural Director of the Office of Faith-Based and Community Initiatives (OFBCI), which the Bush White House created to advance the compassionate conservatism agenda.

An immediate priority for DiIulio and his team was enabling community-based religious nonprofits to compete for government grants and contracts on an equal footing with secular (and often much larger) nonprofits. OFBCI’s working hypothesis – to be tested with data – was that these smaller, community- and faith-based organizations had untapped potential to help solve seemingly intractable social problems. A quick review conducted by OFBCI suggested that, despite several bipartisan “charitable choice” laws passed in Clinton’s second term to help achieve this goal, local faith-based organizations still lacked equal access to federal funding.

As DiIulio would later observe about his time and mission in government,

“Establishing a level playing field for receiving federal funds was both desirable in its own right and a necessary but insufficient condition for achieving the primary, people-helping task….It would be a nice bonus if, after shaking up the government-by-proxy system with new faith-based grantees, federal programs started solving social problems. If this were to happen on a large scale, it could deepen and widen political support for antipoverty and related civic initiatives.”

Unfortunately, this hopeful effort to revamp the hybrid system of service provision quickly ran into obstacles. The acrimonious fallout from the contested 2000 election cut against the bipartisanship that would have been key to the effort’s success. A cadre of White House political operatives, more zealous Republicans in Congress, and Evangelicals sought to use faith-based initiatives to beat up on Democrats. For their part, more liberal Democrats bucked against giving Bush a signature policy win in this area. Then, after 9/11, the focus quickly shifted to countering terrorism and waging wars abroad. The window for reform, open all too briefly, had closed.

A Bird Walk Along the Fiscal Cliff

Here I need to pull the camera back to trace a broader development that is critical for this account. At the same time the Bush Administration de-emphasized reforms to the system of federally-funded, nonprofit-delivered services, it set other forces in motion that have, ever since, eroded this system’s financial underpinnings.

When Bush took office, the federal government was in a strong fiscal position. It had balanced its budget and even run a surplus for four years due to the bipartisan fiscal conservatism and economic growth that had marked Clinton’s second term. During it, federal debt as a percentage of GDP declined from 65% to 55%.

The Bush Administration squandered these hard-won fiscal gains, beginning with the tax cuts it pushed through Congress in 2001 and 2003. Subsequently, instead of raising taxes to pay for the extended wars it led the country to fight in Afghanistan and Iraq, the Bush Administration opted to keep the cuts in place.

The resulting string of budget deficits put the federal government on a very different trajectory. From 2001 through early 2008, federal debt as a percentage of GDP rose back up from 55% to 64%. It has kept rising ever since, with step-change increases during the Great Recession and the COVID pandemic. It currently stands at 121%.

This matters for government-funded nonprofits because they are effectively the last in line for payments from an increasingly stretched federal budget. The de facto priorities are the nation’s creditors (so the government can keep borrowing), followed by the politically untouchable third rails of Social Security and Medicare, and then defense spending. Bringing up the rear are entitlements for poor Americans like Medicaid and SNAP and “non-defense discretionary spending” (budget terminology that itself speaks volumes about the federal government’s priorities).

This final group of programs provides the vast majority of federal funding that goes directly or indirectly (via state and local governments) to nonprofit service providers. They have thus been particularly exposed to the fiscal squeeze that started to tighten back in George W. Bush’s presidency.

New and / or extended tax cuts inexorably work to tighten the budget constraints federally-funded nonprofits face. There is less tax revenue for the federal government to redistribute, all the while the increased federal debt and the rising costs of servicing it further reduce the funding available for nonprofits. Donald Trump’s “One Big Beautiful Bill” is but the latest example of this decades-old pattern.

To cope with the growing gap between their agencies’ responsibilities and the resources they have to discharge them, federal, state, and local government administrators have been relying more heavily on what we might term “mission subsidies” from nonprofits.

These mission-driven nonprofits and the people who work in them are dedicated to carrying out their work, even if the government is not paying them what it takes to deliver the services they provide. Because government agencies tend to operate as monopsonies, i.e., as the market-dominant if not exclusive “buyers” of the services in question, nonprofits often have little choice but to accept the agencies’ terms.

Providers selling to market-dominant buyers on less than favorable terms will inevitably find their enterprises fraying over time. I observed this unwinding first hand from 2005-2013 as a consultant to many government-funded nonprofits. My colleagues and I wrote extensively on the mounting fiscal headwinds buffeting these doughty organizations and various ways in which they could navigate them.

We knew at the time that our recommendations were coping mechanisms and workarounds, not fundamental solutions to the chronic financial squeeze. It had already started to sink venerable nonprofits that had come to rely on government funding. In 2012, for example, Chicago’s Hull House, founded in 1889 by Jane Addams and Ellen Gates Starr, had to close up shop. Meanwhile, another community organizer from Chicago was endeavoring to get the hybrid system back on track.

Barack Obama and the Social Innovation Agenda

The Obama Administration sought to refresh the system with social and financial innovations in support of a bold vision: the federal government would scale up and pay for what works – and stop paying for what does not.

Ashoka Fellow Michele Jolin helped cast this vision with an influential Spring 2008 article in the Stanford Social Innovation Review entitled, “Innovating the White House: How the Next President Can Spur Social Entrepreneurship.” Writing during the presidential primary campaign, Jolin held that

Government investment in models developed by nonprofits is not new: Since the 1960s, the nonprofit sector has served as a test lab for what works in government at all levels; the federal government even adapted a number of successful nonprofit approaches into full-scale programs (AmeriCorps and YouthBuild).

To tackle the problems of the scale and scope our nation faces, however, the next president needs to focus less on replicating individual programs and more on reorienting the government’s relationship toward the nonprofit sector. To do this, he or she should focus on creating a policy environment that fosters greater social innovation and invests in the most high-impact social entrepreneurial efforts.

Jolin went on to propose a new “White House Office of Social Innovation and Impact” that would help the new president carry out this agenda. Her sketch soon became reality. In 2009, Barack Obama set up a White House Office of Social Innovation and Civic Participation (with Jolin serving initially as a senior advisor within it). Over the next several years, the Obama Administration launched several evidence-based policy initiatives with the goal, as the Office’s theory of change subsequently put it, to “find what works…fund what works…and build the enabling infrastructure.”

In June 2009 remarks at a White House event to launch this push, President Obama shared his convictions about its promise:

“The bottom line is clear: Solutions to America's challenges are being developed every day at the grass roots – and government shouldn't be supplanting those efforts, it should be supporting those efforts. Instead of wasting taxpayer money on programs that are obsolete or ineffective, government should be seeking out creative, results-oriented programs like the ones here today and helping them replicate their efforts across America.

The Administration’s overall approach drew on the logic of tiered-evidence models in which promising, early-stage experiments get seed funding, developing programs that have demonstrated initial results receive more funding (and further testing), and those whose impact has been confirmed using the highest standards of evidence get funding to scale at the national level.

The Obama Administration’s evidence-based initiatives included the Social Innovation Fund housed at the Corporation for Community and National Service; the Investing in Innovation (i3) fund at the Department of Education; the Maternal, Infant, and Early Childhood Home Visiting and Teen Pregnancy Prevention programs at the Department of Health and Human Services; and the Workforce Investment Fund at the Department of Labor.

The Administration’s social innovation agenda also rested heavily on the idea of public-private partnerships, especially when it came to funding what works. As the President put it in his 2009 remarks,

“I'm glad that there are some deep pockets in the audience here – foundations, corporations, and individuals. You need to be part of this effort, as well. And that's my challenge to the private sector today.

Our non-profits can provide the solutions. Our government can rigorously evaluate these solutions and invest limited taxpayer dollars in ones that work. But we need those of you from the private sector to step up, as well. We need you to provide that critical seed capital to launch these ideas. We need you to provide those matching funds to help them grow.”

This logic, that government should only invest in programs that demonstrably work, also led the Obama Administration to back “pay for success” schemes like social impact bonds. In this model, philanthropy or private capital would pay up front for the cost of a nonprofit delivering public services to a given population. They would later be reimbursed by government – but only if the nonprofit hit the target outcomes.

Looking back, I cannot help but wonder if both the Obama Administration leaders and the philanthropists that gathered for the 2009 White House event left it having heard what they wanted to believe. Obama and his aides may have presumed that their philanthropic guests were prepared to take on the lion’s share of the funding burden for the work envisioned – and vice versa. But neither side was really in a position to play the role the other side hoped that it would on a sustained basis.

To be sure, for the duration of the Obama Administration, the push to find and fund evidence-based policies and the nonprofits implementing them pressed ahead. But these innovations came at the margins of the federal budget, most of which continued to flow through programs and policies not subject to the same degree of scrutiny. Then, with a few programmatic exceptions, the social innovation agenda was discontinued by first Trump Administration; its very different priorities did not include using data and evidence to assess and refine federal policies in nuanced ways.¹

The Inertia of the Social Services Industrial Complex

Looking back, the successive efforts by the administrations of George W. Bush and Barack Obama to reset our hybrid system of federally-funded, nonprofit-provided services fell short for several reasons.

First, these efforts assumed that not only federal but also state and local administrators and bureaucrats would be creative, nimble, data-driven and open to taking calculated risks. These general dispositions have proven to be elusive, at least at the scale required – especially among the procurement officials and grant program managers who ultimately needed to operationalize the new approach. As a result, despite all the hopes many advocates and funders initially placed in paying for success, the skeptics turned out to be right – it has not been a panacea.

There are, to be sure, many dedicated government leaders and civil servants who have demonstrated the requisite qualities. But they are the exceptional exemplars that unfortunately prove the rule in a massive and complex system of bureaucracies that tends to reward rule-following, turf-guarding, and thus stability over change.

Second, in grounding their proposed shifts on demonstrated evidence of results from the policies, programs, and nonprofits delivering them, advocates subjected their plans to what Peter Rossi termed in 1987 “the iron law of evaluation.” It holds that,

“The expected value of any net impact assessment of any large scale social program is zero.

The Iron Law arises from the experience that few impact assessments of large scale social programs have found that the programs in question had any net impact. The law also means that, based on the evaluation efforts of the last twenty years, the best a priori estimate of the net impact assessment of any program is zero, i.e., that the program will have no effect.”

This “iron law” had been borne out, for example, across a wave of evaluations on the impact of federal social programs, several of which ran all the way back to Lyndon Johnson’s War on Poverty. Brookings Institution scholars noted in 2010 that

“Since 1990, there have been 10 instances in which an entire federal social program has been evaluated using the scientific “gold standard” method of randomly assigning individuals to a program or control group. Nine of these evaluations found weak or no positive effects.”

If hallowed programs like Head Start and Job Corps had failed to deliver positive impact, it called into question whether more nascent programs could demonstrate results if the federal government adopted them at a national scale.

But they never really got the chance. Here we come to a third problem. These new efforts to change the system, for all of their promise, remained minor eddies and tributaries relative to the massive rivers of federal funds that continued to flow to and through the federal agencies, programs and nonprofit service providers that had come to form what I called in 2012 – provocatively but, in retrospect, accurately – “the social services industrial complex.” The inertia built into existing funding flows had, over decades, grown exceedingly difficult to shift, not least because of incumbent nonprofits’ scale, contracting savvy, and political influence.

Collectively, participants in this complex have managed to resist efforts to recast the system by well-intentioned presidents and reformers who saw the pressing need for improvements. Ultimately, however, the complex resisted change at its own peril. Its self-defense mechanisms have shown themselves to be brittle indeed in the face of disruptive political leaders and administrators driven by less constructive intentions who do not care about the purposes the system was originally meant to serve.

This brings us to the final and biggest problem. It would have taken a sustained bipartisan commitment over multiple administrations for the efforts described above to transform our hybrid system of federally-funded, nonprofit-provided service delivery. Somewhere out there on Earth II, where President Jeb Bush won the 2016 election, spent two successful terms implementing a blend of compassionate conservatism and social innovation, and has just handed over the keys of the federal government to newly-elected President Josh Shapiro, this transformation may yet take root. But here on Earth I, where Donald Trump won the 2016 election, and then in 2024 was re-elected to a second term by Americans who had witnessed his first one, the prospect for an inside-the-system transformation has been obliterated.

Leviathan-by-Proxy in Nonprofit Neighborhoods

The critiques of the federally-funded, nonprofit-provided system of service provision surveyed thus far have focused on problems and unanticipated consequences within the system. Before wrapping up, we need to take up two more recent lines of criticism that zero in on problems the hybrid system generates in our democracy.

The first of these critiques arises from the small “c” conservative and Madisonian perspective of John DiIulio. In a spirited 2014 polemic entitled Bring Back the Bureaucrats: Why More Federal Workers Will Lead to Better (and Smaller!) Government, DiIulio took as his point of departure a remarkable discrepancy. While the federal government’s budget had (adjusting for inflation) increased by a factor of five since 1960, its civilian workforce over that same period had remained more or less constant at approximately 2 million.

While elected officials in both parties pride themselves on keeping bureaucracy and big government at bay, DiIulio argued, they have in fact created what he terms “Leviathan-by-proxy.” Government in America is not in fact that small. When factoring in all its levels, our system of government has come to borrow and spend at more or less the same levels per capita as its ostensibly more statist European peers.

But what Americans get from their big government is much spottier, primarily – and this is DiIulio’s key point – because elected officials have outsourced the administration of federal policy to proxies beyond the national government, most notably to for-profit contractors and the non-profits it funds through contracts and grants. This has enabled politicians to pose as enemies of bureaucracy, all the while they create more diffuse, unaccountable, and thus pernicious forms of it.

DiIulio has sharpened this critique over the past decade. As the 2024 presidential campaign heated up, he warned that, “there is a deep state, but it doesn’t emanate from within the federal bureaucracy. The real deep state is the contractor state” (his emphasis), which “uses federal bureaucrats the way sophisticated criminal syndicates use low-level bagmen.” Many large nonprofits are implicated in this scheme:

The real deep state’s heaviest money bags consistently go to mega-corporations via the U.S. Department of Defense. But big nonprofit organizations, including hospitals and universities that pay their executives millions of dollars a year in salaries, benefits, and deferred compensation, also get to drench their beaks.

For instance, in addition to billions of dollars a year in tax-free property and tax-deductible donations, nonprofits registered with the I.R.S. receive about 30 percent of their more than $2 trillion a year in revenues from government grants plus fees for goods and services from government.

DiIulio’s criticism of Leviathan-by-proxy and the nonprofit sector’s involvement in it plumbs how the resulting public-private system confounds democracy in America from the top down. In her 2022 book, Nonprofit Neighborhoods: An Urban History of Inequality and the American State, Claire Dunning, a professor of history at the University of Maryland, explores how this same system has undermined democracy, as well as movements for greater economic and racial equality, from the bottom up.

Dunning’s focus is on how a series of federal urban policies, beginning with the Johnson Administration’s War on Poverty, rippled through American cities. To illuminate and ground her analysis, she follows these efforts as they played out over decades in the “nonprofit neighborhoods” of Boston. Dunning defines these as “places where neighborhood-based nonprofit organizations controlled access to the levers of political, economic, and social power.” She also notes that, with time, “they became spaces of simultaneous inclusion and exclusion, where precarity was more often replicated than reduced.”

Dunning shows that the growth of urban nonprofits in these neighborhoods was “a deliberate goal by Washington bureaucrats and not merely a secondary consequence.” This was because,

“Policy makers recognized grant funding as both a carrot to draw private entities into the work of national programs and as a stick to discipline how they did so. Through this governing tool of incentive and enforcement, Washington helped build – and shape in its desired image – entire networks of community agencies in cities and rural areas around the country.”

Dunning highlights a thorny and persistent problem with the system of nonprofit neighborhoods: it channelled and mediated the voices and interests of residents in ways that muffled direct challenges to the distribution of power within their communities.

Insofar as the neighborhood nonprofits that represent them have depended on government for their core funding, it has tended to divert and constrain “the political power of residents to make the kind of structural, policy-based changes necessary to win full rights of citizenship.”

Moreover, these same nonprofits have often had to turn to wealthy philanthropists whenever government funding has been insufficient to meet their needs, adding yet another set of outside and elite preferences to which they had to respond.

In summing up her assessment, Dunning underscores what she rightly calls an “uncomfortable fact,” namely,

“That inequality and the role of neighborhood nonprofits in urban governance have grown together, not apart. In Boston, the city’s most economically and socially distressed neighborhoods in the twenty-first century are also those with the most neighborhood nonprofits.”

Thus from both the top down and the bottom up, from carefully reasoned and historically-grounded perspectives on the Madisonian right and progressive left, respectively, our public-private system of service provision is depicted as co-opting if not corrupting democracy in America.

It is no surprise, then, that the system finds itself under attack from an emboldened and unabashedly populist administration determined to strip away the institutional power of elites at all levels of American society. Nor is it a surprise that those coming to the defense of the status quo ante hybrid system are not broadly mobilized swaths of American citizens but rather a narrower set of “producer interests” working in or representing the nonprofits affected by the administration’s actions.

What comes next?

I realize for many readers this has been a dispiriting survey of unresolved tensions in the aging hybrid system of federally-funded, nonprofit-delivered services. The individuals, families, and communities the system is meant to help stand no less in need. Indeed, many face ever more troubled circumstances. And countless nonprofits that have long relied on federal funding to help them suddenly find themselves bereft of it. These organizations must now scramble not only to advance their missions but also to make payroll and keep the lights on.

There is no getting around the fact that those of us who seek a more sustainable and legitimate system of social service provision have a lot of work to do. Given the length to which I have already gone, I won’t continue at the even greater length required to preview what shape the alternative(s) might take. Candidly, this would take more foresight than I can marshal at this point. I plan to engage colleagues with different perspectives on this challenge in future posts so we can collectively wrestle with what a better system might consist of – and how we could get from here to there.

In the meantime, the overarching point of this series is simply that the breakdown of the old system is not something we can attribute only, or even primarily, to the administrative tornado that is the second Trump Administration. The system’s sudden toppling resulted from contradictions that, like so many termites, have eaten away at its foundations for decades.

I will close by returning to the theme that we started with in Part I. As Adam Kahane observes in Everyday Habits for Transforming Systems,

“A crack in the system is a sign that, at least for some people, the system is not working. A crack offers a not-yet-realized opportunity to transform the system so that it works better for more people; it presents hope, but also disruption, confusion, conflict, and danger, so moving toward it requires courage.”

We cannot and should not try to piece and glue the now undeniably cracked open hybrid system back together again. But we can work to develop a new system that is more effective, legitimate, and sustainable. That will take courage, and much else. That is the work that lies ahead.

1. The MIECHV and TPP programs continued at the Department of Health and Human Services, and the i3 approach was incorporated and renamed in a new grant program established through the Every Student Success Act.