The Unrelated Business Income Tax, Cost Allocation, and Productive Efficiency

Organizations that otherwise are exempt from federal income taxes are taxed on their net income from business activities that are unrelated to their exempt purpose. This paper examines three settings in which an exempt organization receives income subject to tax. Whether the tax promotes or deters efficiency depends on the extent to which the accounting costs that are deducted for tax purposes correspond to the economic costs of the activity, excluding the cost of equity capital.