The same political and economic volatility that’s shaking this country is also rattling its 1.6 million nonprofit leaders—and they may be feeling the tremors even more deeply.

The stock market and debt crisis have blown holes in the endowments of the nation's biggest philanthropies, and the sector's leaders have been hollowing out their organizations for three years now as volunteering and individual giving remain flat. Meanwhile, efforts to raise revenues through commercial enterprises are being challenged in court. Having been pushed to behave more like businesses for years, many nonprofits are now being treated as such by federal courts.

In a case decided just last month, Federal Appeals Court Judge Richard Posner declared that the “Girl Scouts are not readily distinguishable from Dunkin' Donuts.” In explaining his decision to allow states to regulate the Girl Scout cookie business the way they would a commercial business, Posner opened the floodgates for challenges to camps, daycares, fitness centers, and the rising number of other profit-making activities that many nonprofits have started as a way of reducing dependency on unreliable government contracts, individual contributions and philanthropic grants. 

The decision came on the heels of new data showing continued hard times for sector leaders. The latest survey by Giving USA shows that giving fell by higher percentages in 2008 and 2009 than in any other years over the past five decades. The numbers were far below the hoped-for rise in dollars needed to help victims of the long and seemingly intractable recession. Adjusting for inflation, donations dropped 15 percent – well below the amount needed to keep with rapidly rising demand. 

June also produced an initial tally from the Internal Revenue Service’s purge of nonprofits that failed to file the three consecutive years of tax forms needed to maintain their tax-exempt status. All totaled, 275,000 of the nation's roughly 1.6 million charities lost their papers; and of those, 150,000 or so were traditional public charities that help the needy. The purge will continue into the future with as many as 10,000 nonprofits expected to lose their status each month this summer and fall.       

No one knows just yet which nonprofits went down. But emerging analysis from both the Urban Institute's National Center for Charitable Statistics and Guidestar has already confirmed that most were small organizations that shut their doors, or never quite existed in the first place. Not all of the now-dead organizations were small, however. According to Guidestar, the top 100 organizations that went under had revenue from $4 million to $400 million – which means these nonprofits must have been lazy, sloppy or just plain ignorant. 

The Urban Institute and Guidestar also already know that 25 percent of the revocations involved nonprofits created in the 1990s, and another 25 percent in the 2000s. The rest have been around from time immemorial, many just in a file drawer in someone's basement. Why any of these deceased organizations ever asked for tax-exempt status in the first place is anyone's guess, but the purge leaves the sector lighter and possibly weaker. Moreover, the purge has so far only covered nonprofits that failed to send in their relatively simple tax forms from 2007 to 2009, not yet the ones that may have dropped out as the recession bit even deeper in 2009 and 2010. Expect as many as 50,000 more revocations to come before the end of the calendar year. 

So what's a nonprofit leader to do giving the storms on the horizon?  Many have decide to hollow out their organizations through staff cuts, pay freezes and “holidays” (a ridiculous term for temporary furloughs), and smaller benefit packages. The assumption is that nonprofit employees will make such tradeoffs for the chance to make a difference. As I've argued in the past, the nonprofit workforce is like a toy mouse – wind them up, and they'll do more for less until they are finally doing everything with nothing.    

The IRS purge suggests a different strategy. There was nothing the agency could do given the congressional order to act, and the agency worked hard to find, notify, remind and cajole dilatory nonprofits to file. Although some experts have declared an Armageddon, the purge actually produced a long-overdue cleansing, and stands as a healthy reminder that new nonprofits are not always the best choice for helping people. 

Given the court decisions challenging commercial activity, the downturn in giving, and the continued government negligence, nonprofit leaders need to think harder about transformation. They must attack the duplication and overlap through consolidation with their competitors; flatten their bloated hierarchies and confusing management structures; invest in the frontline workforce that is straining under rising case loads; and harvest these savings for basic investments in the information technologies, training and modest compensation increases needed to assure high performance. 

Nonprofit leaders also have to get much better at measuring the value they produce. They have relied too long on the public's empathy for their revenues, when survey after survey shows that givers want measurable value for their dollars.  Americans understand that there is great need out there, but they are often confused about the impact of their dollars. They continue to believe that nonprofits have the right priorities but waste too much money. They want greater efficiency, not more pictures of needy children.

If a nonprofit cannot explain how every dollar given generates more than a dollar in results, it should close its doors.  

In the meantime, philanthropic organizations should invest in monitoring organizations such as the Urban Institute. What we don't know about the nonprofit sector has hurt us. The sector has been flying blind for years as the recession has taken its toll. It's time to create the backbone to anticipate the future before it arrives. 

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