WASHINGTON -- Not long ago, a Republican political consultant from Southern California was seething at organized labor's success at running ads and mounting voter mobilization efforts for Democratic candidates.
Well-heeled associates told the consultant they would be willing to put up big money for a counterattack -- as long as their involvement could be kept secret.
A continent away in the nation's capital, the head of a major environmental group that tilts toward Democrats was wondering how to handle several prospective donors flush with cash who wanted to make contributions shielded from taxes and public attention.
Both the consultant and the environmental leader seemed to have a problem: The Internal Revenue Service was starting to clamp down on the political activities of not-for-profit groups that are allowed to keep the names of contributors private. Independently, they found new possibilities in Section 527 of the Internal Revenue Code. Lawyers told them that organizations such as theirs could use it to fly below regulatory radar.
Section 527 turned out to be a boon for those wishing to donate quietly. For others committed to public disclosure of how political campaigns are financed, the obscure IRS provision has become the loophole from hell.
"These stealth groups are throwbacks to the off-the-books slush funds of the Watergate era," said Scott Harshbarger, president of the citizens lobby Common Cause. "Just when you thought campaign finance couldn't get worse, it does." These new tax-exempt organizations can raise and spend unlimited sums on behalf of candidates without having to identify donors publicly or reveal how the groups are using those funds.
In addition, the groups can accept direct donations from corporations, labor unions and foreigners -- sources of funding forbidden to candidates or political action committees.
The organizations must file tax forms that identify officers, sources of income and expenditures, according to the IRS. But these documents, unlike those for other not-for-profit groups, are withheld from the public by law. The groups are not required to acknowledge their presence to the Federal Election Commission, which is charged with regulating elections for federal office. They do, however, have to put the name of their organization on any ads they run.
Faces in the shadows
In delegate-rich California, a group called Shape the Debate paid for television ads last month attacking Vice President Al Gore, the likely Democratic presidential nominee, spoofing the game show "Jeopardy" with its version, called "Hypocrisy."
Shape the Debate, which proclaims its devotion to the principles of free enterprise, was developed by longtime associates of former California Gov. Pete Wilson, a Republican. The group's Web site touts the anonymity given its individual and corporate contributors.
Like other Republicans involved in such groups, Wilson strategist George Gorton said he was inspired by advertising and voter mobilization drives conducted by organized labor, even though the unions did not employ the Section 527 loophole.
"I was amazed about what unions were doing in the 1998 political cycle," said Gorton, who helped set up Shape the Debate. "I told my friends it was outrageous, and they said it was a constitutionally protected form of speech. ... I thought there ought to be a business voice."
Gorton said his friends -- businessmen who became his patrons -- wanted to keep their involvement off the public record because they feared retribution from Democrats. So, Gorton gave them a voice, but to ease their skittishness kept their faces in shadow.
The League of Conservation Voters, which tends to support Democrats, has created its own 527 organization, which expects to spend $1.5 million this year.
Deb Callahan, president of the Washington-based league, attempted to distinguish the 527 account run by her well-established group from those such as Shape the Debate, which she called "headless horsemen" that sprout up without warning. But she acknowledged starting her group's 527 offshoot partly to ensure that a handful of wealthy donors could give money to the league anonymously.
A similar group, the Sierra Club, has roughly $7 million to spend on this year's elections from its 527 account, said Bruce Hamilton, the club's conservation director.
Attacking with ads
The handiwork of the so-called 527 groups has been seen in television ads savaging congressional candidates in California, New York, New Jersey, Kentucky and Missouri this campaign season, courtesy of groups with bland names, thick bankrolls and unidentified benefactors. Despite howls from public watchdogs such as Common Cause, it is likely that there will be more such attacks.
"Speech is breaking out all over," chuckled Kentucky Republican Mitch McConnell, the Senate's foremost foe of limiting money in the electoral process. "The federal government spends $1.8 trillion a year. It's not surprising that people would want to have some impact on the government."
Private, tax-exempt interest groups such as U.S. Term Limits and the National Abortion and Reproductive Rights Action League have long been able to run so-called "issue ads" that lambaste or herald specific candidates as long as they do not explicitly endorse or oppose them. But such organizations, unlike the new 527 groups, are required to file publicly available tax documents that reveal some details of their operations, such as their officers.
Political action committees, which can explicitly support candidates, are subject to strict disclosure requirements on gifts and expenditures. They also face limits on who can give them money, how much they can receive from each donor, and how much the PACs can contribute.
The new 527 groups have no such requirements as long as they avoid such phrases as "vote for" or "vote against" an office-seeker.
Growing like mushrooms
Section 527 of the tax code has existed for several decades as the category under which political groups - such as the two national parties and PACs - organize.
In recent years, however, the IRS has questioned the high level of political action by other kinds of nonprofit groups. The Christian Coalition, for example, split in two last year after the IRS refused for a decade to approve it as a tax-exempt group allowed to engage in a variety of political activities. Its Virginia-based core has been reborn as a 527 organization with fewer restrictions.
In conjunction with related IRS decisions, many election lawyers took the Christian Coalition move as a roadmap to the future. As a result, there has been a mushrooming of these new, politically minded groups. Because there are no public filing requirements with either the IRS or the FEC, however, there is no reliable count.
"It's a graphic example of the deterioration of the political system and the influence of special interests," said Arizona Sen. John McCain, who made reforming the nation's campaign finance system a key issue in his failed race for the Republican presidential nomination.
Before last month's "Super Tuesday" primaries, Republicans for Clean Air spent $2.5 million on ads that aired in California and New York attacking McCain's environmental record.
But the group appears to have consisted entirely of billionaire executives Charles and Sam Wyly, brothers who are major fund-raisers for Texas Gov. George W. Bush, then McCain's rival for the nomination. The Wylys acknowledged their involvement only after loud protests from McCain triggered intense press scrutiny. Under current interpretation of the tax and election laws, they were not required to do so.
Bush, the likely GOP presidential nominee, said he has had no hand in the creation of the 527 groups that back him, and he contends that questions about the Wylys hurt his campaign. His campaign finance reform proposals do not address the new type of group. Spokesman Scott McClellan said Bush has said that "he will preserve the right of groups and individuals to speak in the political process."
Gore, calling the 527 loophole "the equivalent of Swiss bank accounts for campaigns," has proposed forcing the groups to disclose much of their activities to the FEC. A Republican-run House committee quashed a Democratic bill with similar requirements this month.
Out of nowhere
Late last fall, Rep. Rush D. Holt, a New Jersey Democrat, was among the first to be targeted by a previously unknown 527 group called Americans for Economic Growth. Television ads questioned the freshman lawmaker's commitment to preserving Social Security.
"All of a sudden, this out-of-state group came from nowhere," said Steve Maviglio, a Holt aide. "There were no records anywhere. No fingerprints on any of this." Since then, Americans for Economic Growth has been linked to people close to House Majority Whip Tom DeLay, a Texas Republican.
Another 527 group, the Republican Majority Issues Campaign, is run by the former director of DeLay's personal PAC. According to one of its officials, lawyer James Bopp Jr., an Indiana Republican, the organization is planning to spend up to $25 million -- much of it raised by DeLay -- to run ads and encourage conservatives to vote.
"If Congress passes a law that says we have to disclose, we will disclose," said Timothy Crawford, a Republican consultant whose corporate-sponsored 527 group conducts opinion polls for senior House Republicans. "I'm just playing by the rules as they've been written."
Restrictions on nonprofits
Different kinds of nonprofit groups face different restrictions on their political activities under tax and election laws. Here is a rundown:
Political action committees:
Can donate up to $5,000 to a candidate each election and $15,000 per political party each year.
May receive up to $5,000 from an individual each year.
Cannot receive direct contributions from corporations or unions.
Must itemize all donations above $200 to Federal Election Commission.
Must itemize expenditures.
Can explicitly endorse or oppose candidates.
"Social welfare" organizations formed under 501(c)(4) section of tax code (interest groups):
Can receive unlimited contributions; can receive direct donations from corporations and unions.
Must file IRS form 990 that provides information to public about organization and its officers. Contributors are identified to IRS but list need not be publicly released.
Can run "issue ads" during elections; under tax law may also engage in more explicit political activities as long as IRS does not find it to be a "substantial" portion of their overall activities.
Under election law, however, any such explicit political activity would require the group to register with the FEC as a PAC and disclose contributions and expenditures.
New 527 groups:
Can receive unlimited contributions; can receive direct donations from corporations or unions.
Must file Form 1120-POL with IRS, but those forms by law are not disclosed to the public; Not required to register with the FEC.
Can run "issue ads" during political campaigns.
Cannot engage in express advocacy political activity, such as running ads explicitly endorsing or opposing candidates, without registering as a PAC with the FEC and following all disclosure requirements.
SOURCE: Common Cause, FEC, IRS