Lecture 22: Public and Non-Profit Finance

What this lecture covers

This lecture asks how finance serves purposes beyond private profit: how nonprofits get funded and run, how governments end up co-owning or controlling supposedly private companies, and how state and local governments and social insurance systems manage risk for the public. It builds on the course's recurring theme that finance is a tool for incentivizing teamwork and managing risk, applied here to organizations that are not driven purely by ownership and profit.

The lecture sits second-to-last in the course, functioning as a broadening of scope after many sessions on private markets and institutions. After watching, you can describe why some ventures are structured as nonprofits, explain the difference between an operating budget and a capital budget in municipal finance, and outline how government social insurance programs like Social Security developed.

Key ideas

• Nonprofit organization: a corporation with a charitable or social purpose, no shareholders, and profits retained for its mission rather than distributed.
• Social entrepreneurship: founding an organization around a mission-driven idea, illustrated through examples like Teach for America, Innovations for Poverty Action, and the Ashoka Foundation.
• Corporate profits tax as partial nationalization: because governments tax a large share of corporate profits worldwide, private companies are never fully separate from government interests.
• Chapter 7 vs. Chapter 11 bankruptcy: Chapter 7 liquidates a company; Chapter 11 restructures it so the business can continue operating, as happened with General Motors.
• Operating budget vs. capital budget: state and local governments must balance their operating budgets by law but can borrow for capital projects like schools and sewage systems.
• Municipal bonds: debt issued by local governments (and some universities) that is exempt from federal income tax, giving it a lower yield and particular appeal to higher-income investors.
• Social insurance: government-provided protection against income shocks, including progressive taxation, public education, and Old Age, Survivors, and Disability Insurance (OASDI).
• Information technology and bureaucracy: Shiller argues that innovations like cheap paper, carbon paper, typewriters, and postal services enabled Germany to launch the first national social insurance system in the 1880s.

Walkthrough

Why organized causes need financing (0:00)

Shiller opens by arguing that even seemingly individual achievements, such as Einstein's physics or Darwin's voyage on the Beagle, depended on institutional support: universities, journals, and patrons. This sets up the lecture's broader claim that good work is almost always a team effort that needs financing, whether through for-profit, nonprofit, or government channels.

Nonprofits and their founders (6:45)

The lecture defines nonprofits as organizations with a charitable purpose and no shareholders, noting that the U.S. had about 1.6 million of them in 2010, accounting for roughly 4% of GDP. Shiller walks through examples of people who built nonprofits around a specific idea: Peter Tufano's Doorways to Dreams, Dean Karlan's Innovations for Poverty Action, Bill Drayton's Ashoka Foundation, and Wendy Kopp's Teach for America, which she founded from a Princeton senior thesis. He also traces the nonprofit origins of two New Haven hospitals, Yale New Haven and St. Raphael's, to argue that framing a venture as nonprofit can unlock funding and trust that a for-profit structure would not.

Government involvement in for-profit companies (18:55)

Shiller argues that corporate profits taxes, which run as high as roughly 47% combined in the U.S. and are common worldwide, effectively make governments partial owners of private companies. He illustrates this with two case studies: TEPCO, whose share price collapsed after the Fukushima disaster and which faced massive liability claims, and General Motors, which filed for Chapter 11 bankruptcy during the financial crisis and emerged partly owned by the U.S. and Canadian governments and the United Auto Workers union. He contrasts Chapter 7 liquidation with Chapter 11 reorganization and notes that nonprofits also resemble for-profits in practice, citing a statistic that 42% of nonprofits pay executive bonuses.

Municipal and state finance (36:43)

State and local governments in the U.S. spend roughly twice as much as the federal government and typically operate under balanced-budget rules for their operating budgets, while financing infrastructure like schools and sewage systems through a separate capital budget funded by borrowing. Shiller explains why a small town might borrow heavily to build infrastructure sized for future growth, and the resulting bankruptcy risk if growth does not materialize, referencing Chapter 9 of the bankruptcy code and New York City's near-bankruptcy in the 1970s.

Tax-exempt municipal debt (46:06)

The lecture explains that municipal bonds, and similarly Yale University's own bonds, are exempt from federal income tax, which lowers their yield but makes them attractive to higher-income investors. Shiller notes that Yale carries billions in debt despite a large endowment partly because tax-subsidized borrowing is advantageous when used for appropriate purposes, and observes that the federal government, unlike states, has no capital budget.

Government social insurance (51:24)

Shiller defines social insurance as protection against income shocks not typically offered by private insurers, including progressive taxes with an earned income tax credit, free public education, and OASDI (old age, survivors, and disability insurance). He explains why private markets struggle to offer some of these products, such as disability insurance, due to selection bias.

The German origins of social insurance (1:00:10)

Germany under Otto von Bismarck launched the first national social insurance programs in the 1880s, which contemporaries doubted could be administered reliably. Shiller argues this was made possible by information technology advances, including cheap machine-made paper, carbon paper, typewriters, standardized forms, and a national postal service used to collect contributions and pay benefits, contrasting Germany's success with the earlier failed Speenhamland experiment in England.

Before you watch

• Earlier lectures on corporate finance and bankruptcy provide useful background for the General Motors and Chapter 7/Chapter 11 discussion.
• Basic familiarity with how income taxes and bonds work will help with the sections on municipal finance and tax-exempt debt.

Check your understanding

1. Why might founders choose to structure a venture as a nonprofit rather than a for-profit company?
2. In what sense does a corporate profits tax make a government a partial owner of private companies?
3. What is the difference between an operating budget and a capital budget for a city government, and why does the distinction matter for municipal bankruptcy risk?
4. What information technologies does Shiller credit for making Germany's 1880s social insurance system feasible?