When Congress first created tax exemptions for nonprofit organizations in 1894, the goal was simple: Support charitable institutions serving the public good. Today, that well-intentioned policy has morphed into a sprawling system that shields roughly 15% of the U.S. economy, approximately $3.3 trillion in annual revenue, from taxation. As America grapples with mounting federal debt and annual deficits, it’s time to reform this antiquated system that distorts markets and shifts the tax burden onto other businesses and individuals.

Consider credit unions, which were originally granted tax-exempt status to serve people of modest means. Today, they manage more than $2 trillion in assets, and many operate virtually indistinguishable from commercial banks, even purchasing them outright. In the past decade, credit unions have bought nearly 100 banks, using their tax advantage to expand far beyond their original mission. The Michigan-based Lake Michigan Credit Union, for instance, now finances aircraft purchases and operates multiple branches in Florida — activities far removed from serving low-income Michigan residents.

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The healthcare sector provides another striking example. Nonprofit hospitals generated $1.4 trillion in revenues and $61 billion in tax-free net income in 2019. The tax-exempt NYU Langone Health recently spent an estimated $8 million to run a 30-second Super Bowl ad. Yet research shows nonprofit hospitals provide no more charity care than their for-profit counterparts. Had these profitable health systems been taxed at the standard corporate rate of 21%, they could have contributed about $13 billion in federal revenue.

Even elite universities have become massive tax-exempt businesses. In 2019, 51 private universities each reported more than $1 billion in revenues. Their investment arms manage hundreds of billions in assets tax-free, while nearly 70% of their income comes from commercial activities such as tuition, sports revenues, and dormitory rents — not charitable donations.

The problem isn’t that these organizations exist or that they’re profitable. It’s that they enjoy special tax privileges while competing directly with taxpaying businesses. This creates an uneven playing field and erodes the tax base at a time when the federal debt exceeds 120% of GDP and interest payments alone topped $1 trillion last year.

The solution isn’t to eliminate tax exemptions entirely but to modernize them. Congress should replace the current system’s vague “relatedness” test for business income with a clearer standard: Commercial activities should be taxed similarly whether conducted by nonprofit or for-profit entities. Legitimate charitable donations would remain tax-exempt, preserving incentives for genuine philanthropic work while ensuring fair competition in commercial markets.

This reform could generate as much as $40 billion annually in new revenue without raising tax rates or harming truly charitable work. It would level the playing field between tax-exempt and taxpaying businesses, possibly fostering more efficient markets and better services for consumers.

Critics may argue that taxing nonprofit organizations’ commercial activities would harm their charitable missions. But the evidence suggests otherwise. Many of these organizations operate like businesses precisely because they’ve grown well beyond their charitable roots. Their tax advantages now mainly benefit their own expansion rather than the public good.

This was exactly what many feared when Congress created the corporate income tax in 1909, and politicians rushed to exempt their favored constituents from the new tax. The rapidly expanding list of exemptions prompted some lawmakers to warn about the dangers of groups taking advantage of the expansive way Congress had defined a tax-exempt business.

Then-Sen. Weldon Heyburn (R-ID) chided his colleagues, saying, “Knowing as I do that you can call one of these concerns a ‘mutual benefit association,’ a ‘building association,’ or anything else, when it really may be a bank. I am merely calling attention to the fact that there will be very little left upon which to collect this [corporate tax] revenue.”

Congress has successfully tightened these tax-exempt rules before. Tax reform bills in 1951 and 1986 removed exemptions for various mutual organizations when their original justification no longer applied and it had become obvious that they were competing directly with for-profit firms. Similar courage is needed today.

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As the national debt grows and interest payments consume an ever-larger share of federal spending, we can no longer afford to maintain a vast tax-exempt commercial sector based on century-old rationales. Reform would enhance market efficiency, broaden the tax base, and restore fairness to our tax system — all while preserving genuine charitable work.

The time has come to modernize our approach to nonprofit taxation, ensuring all commercial enterprises compete on equal terms while protecting true charitable activities. Our fiscal health and economic efficiency depend on it.

Scott Hodge is a tax and fiscal policy fellow at Arnold Ventures. Roger Meiners and Andrew P. Morris are professors at the University of Texas at Austin and Texas A&M University, respectively. This essay is based on their recent academic study, “Ring Fencing Bad Tax Policy.”