E. FINANCIAL TRANSACTIONS UNRELATED TO CHARITABLE FUNCTIONS

Private foundations necessarily engage in many financial transactions connected with the investment of their funds. Experience has, however, indicated that unrestricted foundation participation in three classes of financial activities which are not essential to charitable operations or investment programs can produce seriously unfortunate results.

Some foundations have borrowed heavily to acquire productive assets. In doing so, they have often permitted diversions of a portion of the benefit of their tax exemptions to private parties, and they have been able to swell their holdings markedly without dependence upon contributors. Certain foundations have made loans whose fundamental motivation was the creation of unwarranted private advantage. The borrowers, however, were beyond the scope of reasonable and administrable prohibitions on foundation self-dealing, and the benefits accruing to the foundation's managers or donors were sufficiently nebulous and removed from the loan transactions themselves to be difficult to discover, identify, and prove. Some foundations have participated in active trading of securities or speculative practices.

The Treasury Department recommends special rules to deal with each of these three classes of unrelated financial transactions. First, it proposes that all borrowing by private foundations for investment purposes be prohibited. Second, it recommends that foundation loans be confined to categories which are clearly necessary, safe, and appropriate for charitable fiduciaries. Third, it proposes that foundations be prohibited from trading activities and speculative practices.

F. BROADENING OF FOUNDATION MANAGEMENT

Present law imposes no limit upon the period of time during which a donor or his family may exercise substantial influence upon the affairs of a private foundation. While close donor involvement with a foundation during its early years can provide unique direction for the foundation's activities and infuse spirit and enthusiasm into its charitable endeavors, these effects tend to diminish with the passage of time, and are likely to disappear altogether with the donor's death. On the other hand, influence by a donor or his family presents opportunities for private advantage and public detriment which are too subtle and refined for specific prohibitions to prevent; it provides no assurance that the foundation will receive objective evaluation by private parties who can terminate the organization if, after a reasonable period of time, it has not proved itself; and it permits the development of narrowness of view and inflexibility in foundation management. Consequently, the Treasury Department recommends an approach which would broaden the base of foundation management after the first 25 years of the foundation's life. Under this proposal, the donor and related parties would not be permitted to constitute more than 25 percent of the foundation's governing body after the

This recommendation would not prevent foundations from borrowing money to carry on their exempt functions.

expiration of the prescribed period of time. Foundations which have now been in existence for 25 years would be permitted to continue subject to substantial donor influence for a period of from 5 to 10 years from the present time.

III. ADDITIONAL PROBLEMS

Review of the practices of private foundations and their contributors discloses the existence of several problems which have less general significance than those discussed in Part II of the report. Part III of the report draws the following conclusions about these problems: A. Gifts to private foundations of certain classes of unproductive property should not be deductible until the foundation sells the property, makes it productive, applies it to a charitable activity, or transmits it to a charitable organization other than a private foundation.

B. Charitable deductions for the contribution to private foundations of section 306 stock (generally, preferred stock of a corporation whose common stock is owned by the donor) and other assets should be reduced by the amount of the ordinary income which the donor would have realized if he had sold them.

C. Reforms of a technical nature should be made in certain estate tax provisions which govern tax incidents of contributions to private foundations.

D. A sanction less severe than the criminal penalty of existing law should apply for the failure to file a return required of a private foundation.

These Treasury Department proposals are based upon a recognition that private foundations can and do make a major contribution to our society. The proposals have been carefully devised to eliminate subordination of charitable interests to personal interests, to stimulate the flow of foundation funds to active, useful programs, and to focus the energies of foundation fiduciaries upon their philanthropic functions. The recommendations seek not only to end diversions, distractions, and abuses, but to stimulate and foster the active pursuit of charitable ends which the tax laws seek to encourage. Any restraints which the proposals may impose on the flow of funds to private foundations will be far outweighed by the benefits which will accrue to charity from the removal of abuses and from the elimination of the shadow which the existence of abuse now casts upon the private foundation area.

PART I. APPRAISAL OF PRIVATE FOUNDATIONS

The Internal Revenue Code provides very significant preferential treatment for philanthropic organizations. Not only does it exempt such organizations from income tax (a status they share with many other nonprofit organizations), but it grants income, gift, and estate tax deductions to persons contributing funds to them. The allowance of these deductions results in a very sizable reduction in tax revenues. In 1963, for example, the charitable deductions claimed by individuals, corporations, and estates diminished Federal revenues by a total of approximately $2,800 million.1

While private foundations have, in general, received the same favorable treatment accorded all philanthropic organizations, several noteworthy qualifications have been made for them. In 1950 rules concerning prohibited transactions (now secs. 503 and 681(b)) and unreasonable accumulation of income (now secs. 504 and 681(c)) were applied to foundations. In 1964, when Congress increased the general limitation upon the amount of deductible charitable contributions which individuals can make each year from 20 percent of adjusted gross income to 30 percent, it excluded donations to private foundations from the increase (continuing the 20 percent ceiling on them). At the same time, Congress placed special limitations upon the kinds of foundations which can qualify to receive the unlimited charitable contributions permitted to individuals in certain instances. The limitations were designed, generally, to confine this privilege to foundations which do not engage in financial transactions with their donors or related parties, and which actively engage in charitable operations or which pass funds on to active charities without undue delay. A third differentiation between private foundations and other classes of philanthropic organizations occurred in 1964 legislation: in initiating a provision allowing individuals a 5-year carryover of charitable contributions which, in a particular year, exceed deductible limits, Congress did not extend this benefit to contributions made to foundations.

The 1964 decisions by Congress restricting the favorable tax treatment accorded private foundations represent a carefully considered balancing of the relative needs and values of foundations against those of other kinds of charitable organizations. The Treasury Department concurs in the judgment of Congress on these matters; it should be allowed to stand. The vital present question is whether or not additional restrictions are necessary.

To provide an informed response to this question, one must inquire into several fundamental problems. What are the values of private philanthropy? Do private foundations contribute to them? If so, what is the character of that contribution? Is it likely to be attended by undesirable consequences? Are specific measures available to

1 This total does not, of course, represent a net loss to the Government. As is pointed out in greater detail below, private charitable expenditures reduce the need for Government spending.

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forestall such consequences, or can they be dealt with only by provisions of general scope?

A. PHILANTHROPIC VALUES AND PRIVATE FOUNDATIONS

The income tax deduction for individuals' gifts to charity was added to the law in 1917, at a time when income tax rates were being raised to meet the expense of war. The addition was justified on the ground that heavy income taxes might cause reductions in donations to charity. Similar considerations subsequently led to the enactment of gift and estate tax deductions for charitable transfers and the extension of the income tax deduction to corporations.

It is impossible accurately to assess the gain or loss in Government funds resulting from the charitable deduction. We cannot know by what amount charitable contributions would be reduced if there were no tax deductions for them. Similarly, we cannot know what increase in Government spending would be required to compensate for reduced charitable spending.

A more important imponderable exists-the distinctive value of private philanthropy. Such philanthropy plays a special and vital role in our society; Government services cannot provide a satisfactory substitute. Religious activity is perhaps unique, because Government is constitutionally barred from undertaking it. Here, private freedom of choice is the preeminent consideration. But in other fields, too, Government is best restricted to a partial and, perhaps, minor role. Research in some of the more controversial areas of the social sciences is an example. Even with respect to activities in which Government must take a major part today-such as education, social security, relief and elimination of poverty-charitable organizations may make vital and unique contributions.

Private philanthropic organizations can possess important characteristics which modern government necessarily lacks. They may be many-centered, free of administrative superstructure, subject to the readily exercised control of individuals with widely diversified views and interests. Such characteristics give these organizations great opportunity to initiate thought and action, to experiment with new and untried ventures, to dissent from prevailing attitudes, and to act quickly and flexibly. Precisely because they can be initiated and controlled by a single person or a small group, they may evoke great intensity of interest and dedication of energy. These values, in themselves, justify the tax exemptions and deductions which the law provides for philanthropic activity.

Private foundations play a significant part in the work of philanthropy. While the foundation is a relatively modern development, its predecessor, the trust, has ancient vintage. Like its antecedent, the foundation permits a donor to commit to special uses the funds which he gives to charity. Rather than being compelled to choose among the existing operating organizations, he can create a new fund, with its own areas of interest and emphasis. His foundation may encourage existing operating organizations to develop in new directions, or it may lead to the formation of new organizations. Even if it does neither, it reflects the bents, the concerns, and the experience of its creator; and it thereby increases the diversity of charitable works. In these ways, foundations have enriched and strengthened the pluralism of our social order.

Private foundations have also preserved fluidity and provided impetus for change within the structure of American philanthropy. Operating charitable organizations tend to establish and work within defined patterns. The areas of their concern become fixed, their goals set, their major efforts directed to the improvement of efficiency and effectiveness within an accepted framework. Their funds are typically consigned to definite and growing-budgets. The assets of private foundations, on the other hand, are frequently free of commitment to specific operating programs or projects; and that freedom permits foundations relative ease in the shift of their focus of interest and their financial support from one charitable area to another. New ventures can be assisted, new areas explored, new concepts developed, new causes advanced. Because of its unique flexibility, then, the private foundation can constitute a powerful instrument for evolution, growth, and improvement in the shape and direction of charity.

B. EVALUATION OF GENERAL CRITICISMS OF FOUNDATIONS

Several serious general criticisms have been leveled at the private foundation. Some argue that the interposition of the foundation between the donor and active charitable pursuits entails undue delay in the transmission of the benefits which society should derive from charitable contributions. Others contend that foundations are coming to constitute a disproportionately large share of our national economy and hence, among other things, are biting deeply into our tax base. Still others urge that foundations represent dangerous concentrations of uncontrolled economic and social power. Such contentions have led to proposals that a time limit be imposed on the life of private foundations.

The Treasury Department does not believe that a case for this proposal has been made. Its investigation has indicated that most private foundations act responsibly and contribute significantly to the improvement of our society. Because of the very nature of their activities and aims, precise judgment is impossible upon the extent to which foundations have realized their potentialities for creative and dynamic charitable works. It seems quite clear, however, that their endeavors have been conducive to important advancements in education, health, science, the arts, religion, and assistance to the needy and unfortunate.

The argument that foundations can occasion unwarranted delay in benefits to charity possesses considerable force; for, in particular situations, there have been aggravated instances of such delay. But the appropriate solution would appear to be a measure specifically designed to deal directly with this problem-not a rule, like the proposal for limiting foundation life, whose impact would extend well beyond the boundaries of the problem itself. Part II-B of the report outlines a recommendation framed to meet the specific exigencies of the delay problem; and the Treasury Department believes that the measure will prove adequate to its task.

The contention that foundation holdings have become an excessively large part of the national economy in recent years finds little support in the relevant data. Appendix A explores this matter in some detail. While the available information is far from definitive, it suggests that,