During the last week of June, as Congress was rushing toward its annual Fourth of July recess, the House and Senate abruptly acted to close the newest loophole in the federal election laws. Under an obscure provision of the Internal Revenue Code, Section 527, largely unregulated organizations get all the tax benefits provided to political parties and political action committees operated by corporations, unions, and other groups. But unlike traditional political groups, a Section 527 organization can conceal both its donors and its beneficiaries. Thus, 527 organizations have been beautifully positioned to influence elections, free from scrutiny--hence the nickname "stealth PACs." The new law, for the first time, requires public disclosure.
Section 527 organizations have been established by trade groups and wealthy individuals close to candidates in order to mask who is actually providing funds. Republicans for Clean Air, a 527 organization reportedly funded by Sam and Charles Wyly, gained notoriety during the New York presidential primary race when it published ads attacking the environmental record of Senator John McCain. This was, of course, a purely ad hoc paper organization with enough distance from George W. Bush to give him what the CIA used to call "plausible deniability" when he was asked if he knew anything about the group. When President Clinton signed the reform bill on July 1, he cited a 527 organization calling itself Citizens for Better Medicare, apparently funded by the pharmaceutical industry, which has "flooded the airways with negative ads against [the administration's] prescription drug plan."
The bill marks the first time Congress has closed a campaign finance loophole in more than two decades. But it's not clear whether this is a real step forward or just a step sideways into a complex thicket of First Amendment concerns. Nor is it clear whether this unexpected small step builds momentum for fundamental reform.
Although the growth of 527 organizations started with the 1996 election cycle, they became this year's loophole of choice for many party leaders, wealthy individuals, and advocacy organizations of both the left and the right. Majority Whip Tom DeLay has been linked to a 527 organization, the Republican Majority Issues Campaign, formed to help the Republican Party keep its majority in the House of Representatives. According to Common Cause, the chairman of the House Republican Conference, J.C. Watts, is serving as honorary chair of another 527, Saving America's Families Everyday. Progressive organizations such as the Sierra Club, Business Leaders for Sensible Priorities (established by the founder of Ben & Jerry's ice cream), and Peace Action (formerly SANE/FREEZE) have also established 527s for the 2000 election.
The bill passed by Congress does not shut down these organizations, which would be constitutionally suspect, nor does it attempt to regulate the "issue ads" the 527s support with large soft money contributions. Instead, the groups must now disclose their contributors and expenditures to the IRS and make these reports available to the public upon request. This puts them on the same footing as PACs and parties. Republican leaders in the Senate and House opposed even this modest reform on the grounds that the bill does not require similar reporting of issue ads and other campaign-related activities by unions, advocacy groups, and professional organizations such as the Association of Trial Lawyers. The Republicans tried to substitute a broader disclosure proposal that campaign reformers considered a "poison pill" meant to kill their narrower proposal aimed just at 527s.
Republican arguments against the bill probably would have prevailed but for McCain's highly visible run for the Republican presidential nomination. When he returned to the Senate after his defeat in the Super Tuesday primaries on March 9, McCain announced that his first priority would be to enact comprehensive campaign finance legislation. In pushing the 527 disclosure bill, reformers sought to capitalize on the attention given to McCain and the campaign reform issue during the primaries, and to gain a small victory to generate momentum for more significant reforms. The support given to the disclosure bill by Republican moderates, and ultimately by the party's leadership, however, may reflect more of a desire to deny the Democrats an election year issue than a lasting commitment to more comprehensive campaign finance reform.
Nonprofits and Electoral Politics
The debate over regulating stealth PACs reflects long-standing controversies about the role of nonprofit organizations in the political process that are certain to be raised again. Nonprofit, tax-exempt organizations have a legitimate right to express viewpoints on public issues and even, within broad limits, to lobby. But when they become de facto front groups for political campaigns, they cross a line that Congress intended to regulate in the post-Watergate reforms. How to re-establish that line without harming legitimate nonprofits presents a very tricky set of constitutional questions that the Supreme Court addressed, perhaps clumsily, in Buckley v. Valeo, and an even trickier politics. The effort to enact a narrow bill to force Section 527 organizations to disclose their finances very nearly backfired and produced an overly broad bill that would have constrained First Amendment rights of bona fide nonprofits.
The huge growth of soft money contributions to the Republican and Democratic parties to support issue advertisements and other partisan communications, which came to a head in the 1996 election cycle, had two major drawbacks for party fundraisers: While the Federal Election Commission (FEC) has refused to prohibit soft money contributions to political parties, it has required national party committees such as the DNC and the RNC to list the donors. Moreover, the FEC requires parties to pay as much as 65 percent of the costs of issue advertising and other similar expenditures with hard money, although the remainder may be covered from their soft money accounts. In contrast, under the Supreme Court's 1976 decision in Buckley and other decisions, 527 organizations not connected to a political party have neither of these disadvantages so long as they are limited to running issue advertisements attacking (or supporting) candidates for their positions but stopping short of any statements expressly urging the public to vote for or against these candidates. They need not register with or report to the FEC or comparable state election agencies regarding their activities, and they may use 100 percent unregulated soft money to support the issue ads.
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Section 527 organizations that operate outside the party apparatus also have significant tax advantages over other types of nonprofit organizations, particularly social welfare organizations exempt under Section 501(c)(4) of the Internal Revenue Code that are used to carry on lobbying and limited political activities. Section 527 organizations are not restricted by the IRS rule that requires social welfare organizations to engage primarily in nonpolitical activities. Nor are they subject to a special excise tax that the IRS is empowered to assess on political activities conducted by 501(c)(4)s. Also, individual donors may contribute sums to 527 organizations far in excess of the annual federal gift tax exemption of $10,000 without paying the steep federal taxes they must pay on their large contributions to 501(c)(4)s. In order to obtain these tax benefits, some 501(c)(4) organizations have recently reorganized as 527s, and other 501(c)(4)s have established 527s to house their political activities in connection with the 2000 elections.
During the Senate Government Affairs Committee's investigation of campaign abuses in the 1996 election, Democrats on the committee accused Triad Management Services, a conservative political fundraising firm, of funneling large contributions from undisclosed donors to two shell 501(c)(4) organizations, Citizens for Reform and Citizens for the Republic Education Fund, which together spent between $3 million and $4 million on television ads in support of Republican candidates in 29 House and Senate races. After questions were raised about the bona fides of these organizations' status under Section 501(c)(4), in October 1997, the Associated Press reported that they planned to reorganize as 527 organizations. After the IRS denied the Christian Coalition's long-standing application for tax exemption under Section 501(c)(4), the organization reportedly reorganized under Section 527.
Closing the Loophole
Facing the threat of a filibuster from the same Republican senators who had successfully killed earlier efforts at comprehensive campaign reform, McCain announced after his return to the Senate that he would attach it, or some modified version, to any filibuster-proof legislation that came before the Senate. On June 7, he offered an amendment to the Defense Department authorization bill to require Section 527 organizations that do not already report to the FEC to file a public notice of their existence, submit periodic reports of their contributions and expenditures to the IRS, and file an annual information tax return similar to the returns filed by 501(c)(4) and other tax-exempt organizations. The amendment was based on a bill previously introduced by Senator Joseph Lieberman. After easily overcoming a procedural point of order with the support of 13 Republicans and all but one of the Democrats voting, the McCain-Lieberman amendment was adopted the next day by a voice vote. Sensing a groundswell of support and not wanting to give the Democrats an election year issue, Senate Republican leaders who had opposed the McCain-Lieberman amendment, including Majority Leader Trent Lott and Senator Mitch McConnell, quickly backed a bill introduced on June 15 by Senator Gordon Smith of Oregon. This bill included the McCain-Lieberman amendment, but added provisions to require labor organizations and trade associations, both of which are tax-exempt under other sections of the Internal Revenue Code, to file reports on issue ads and any other political activities that were not already being reported to the FEC.
In the House, meanwhile, House Minority Leader Richard Gephardt announced May 18 that House Democrats would file discharge petitions to force action on two bills requiring disclosure by 527s. The House twice before had passed comprehensive finance reform legislation sponsored by representatives Christopher Shays and Martin Meehan. Sensing their margin was slipping, Republican House leaders were pressured into agreeing that a broader form of disclosure legislation, to be drafted by New York Representative Amo Houghton, would be brought to the floor prior to the June 30 holiday recess.
After holding a rapidly-put-together day of hearings, the House Committee on Ways and Means voted on June 24 to report a bill, H.R. 4717, initially drafted by Houghton and amended in committee by Ways and Means Chairman Bill Archer, which covered social welfare organizations, unions, and trade associations, along with Section 527s. The vote to report the Houghton-Archer bill was along partisan lines, with Democrats opposing the bill because of its coverage of organizations other than 527s, which they regarded as a "poison pill." After lengthy negotiations with Democrats and moderate Republicans from both the House and Senate, including McCain and Lieberman, the House leadership decided on June 27 that they did not have the votes to pass the broad Houghton-Archer bill and instead brought to the House floor a bill virtually identical to the McCain-Lieberman amendment passed in the Senate. It was this narrow 527-only bill that overwhelmingly passed the House late in the evening of June 27 and, two days later, the Senate.
Campaign Finance Reform?
Whether the new disclosure law will have any significant effect on soft money ads remains an open question. Except for the small number of high-profile 527s reported in the media, it has never been clear how many such organizations actually exist or how much they planned to spend on overtly political activities distinct from grass-roots lobbying and other bona fide voter education projects (this murkiness is, of course, why disclosure legislation was needed in the first place). The IRS must also decide whether the law applies to a large number of political action committees, such as the so-called "leadership PACs" created by many members of Congress to raise funds for other members of their party, that report some of their activities to the FEC but do not report to the FEC on their soft money activities.
The new 527 disclosure requirements may in the end only force some of these groups to reorganize under other provisions of the tax code that do not require disclosure of donors, as Representative DeLay predicted in a post-enactment statement. On the other hand, Section 527 groups connected to politicians and controversial causes may also face some political fallout if they immediately reorganize under other provisions in order to avoid disclosing their contributors. Groups funded by a small number of rich individuals, such as the Texas millionaires who attacked McCain, may simply continue their issue advertising as individuals without any formal structure. Other groups, however, may decide that the tax benefits available under 527 are worth the added disclosure. It is even conceivable that the new 527 requirements may be struck down by the courts as violating the First Amendment, although supporters of the bill are confident this is unlikely in light of the broad latitude historically afforded by the courts with similar restrictions imposed by the government in return for tax exemption.
The debate over the 527 legislation left unresolved the question of disclosure of political activities conducted by other tax-exempt organizations, in particular social welfare groups, unions, and trade associations. Unlike charitable and educational organizations exempt under Section 501(c)(3), which are absolutely forbidden from intervening in any campaign for public office, these other organizations frequently engage in substantial political activities by providing administrative and fundraising support for their hard money political action committees, distributing partisan messages to their members, using their treasury funds to distribute voter guides and other get-out-the-vote messages, and sponsoring issue advertisements. While these organizations are required to identify their large contributors in their annual tax returns, this information is currently exempt from the public-disclosure rules applicable to other parts of the tax return, and they do not have to identify their expenditures made for political purposes at all.
Mandatory disclosure of political activities by other tax-exempt organizations, however, raises more difficult constitutional questions than legislation limited to 527s, as Common Cause and other campaign reformers pointed out in successfully opposing the broader Republican alternatives to McCain-Lieberman. It is extremely difficult, if not impossible, for example, to craft disclosure legislation for tax-exempt organizations whose major purposes are not political without interfering with organizations' constitutionally protected public education, lobbying, and other nonpolitical activities. Also, requiring disclosure of contributors to the Sierra Club, the NRA, the AARP, or other similar groups can run afoul of Supreme Court decisions protecting organization membership lists from compelled public disclosure on freedom of association grounds. It is also questionable whether tax-exempt organizations other than the avowedly political 527s should be forced to undertake the burden of disclosing permissible political activities when rich individuals, for-profit businesses, and other entities that conduct issue advertising and soft money political activities are not subject to the same rules.
More fundamentally, it's not clear what effect the new Section 527 legislation will have on broader efforts at campaign finance reform, including legislation to prohibit soft money contributions to political parties. Senator McCain and the other reformers in the House and Senate have already announced they will use the momentum gained from the 527 fight to push for a ban on soft money contributions to the parties and other provisions, but they can hardly be expected to say otherwise. Republicans in Congress, on the other hand, may believe that they now have the political cover they need to defuse campaign reform as an issue in the November elections, and be more reluctant to defy their party leadership again if comprehensive reform is brought up soon. Moreover, even if Congress ultimately prohibits soft money contributions to political parties, the debate over the 527 disclosure legislation makes clear that politicians, fundraisers, and parties already have in place a network of private, nonprofit groups to receive these funds so long as they are willing to disclose the groups' activities. In an area of public policy where the law of unintended consequences is usually at work, it will be ironic indeed if the first campaign reform legislation to pass Congress in many years results in deferring the broad reforms necessary to curtail the unbounded infusion of money into political campaigns. ¤