Clearly, it would be very difficult to judge whether the El Pomar Foundation's manner of operating the Broadmoor Hotel is such that none of the concerns addressed by the excess business holdings rules are relevant. In fact, the excess business holdings rules are a response to the tremendous difficulties encountered in attempting to determine on a case-by-case basis whether a particular foundation's ownership of a business results in abuses. We believe these rules are preferable to the intrusive audit activity that otherwise would be necessary to ensure that charitable assets invested in a business sare dedicated solely to charitable purposes. I appreciate the opportunity to provide you with the Treasury Department's views on S. 1464. Sincerely, Paweld Neat Ronald A. Pearlman Deputy Assistant Secretary (Tax Policy) The Honorable William L. Armstrong 20510 Senator ARMSTRONG. Well, we will follow up on that. And I would like to ask that someone from your office take a close look at that because the intention of this bill in its present form is to deal only with El Pomar. As you know, the Senate has on two previous occasions agreed to such legislation, once in 1969 and again last year. And there are a number of other foundations who may wish to avail themselves to similar legislative treatment and, in fact, we may package something up. But the bill in its present form only applies to El Pomar. And I think that is very significant in view of your other testimony. You mentioned in your testimony quite a number of abuses that were the cause of the legislation in the first place. On page 13 of your testimony you state the following: "These noncharitable uses included self-dealing between foundations and donors, undue delay in the delivery of benefits to charity, extensive foundation involvement in businesses resulting in noncharitable use of charitable assets, family use of foundations to control corporate and other property, and financial transactions unrelated to charitable functions." I would just like to say to the Department that if I or the others who are interested in this legislation believe that such circumstances applied to El Pomar I would not personally sponsor such legislation. But for the record-and by the way, we have every assurance that there are none of these kinds of circumstances which clearly were prevalent among some foundations-that none of these apply in the case of El Pomar. I would like to ask if the Treasury has any reason to think that such circumstances do apply to this situation. Mr. PEARLMAN. No, we do not, Mr. Chairman. I think the problem with any broadbased legislation such as the private foundation legislation in 1969 is that it is going to sweep into it some foundations that need to be dealt with and some that do not. If you are going to enact this kind of legislation on a fair, broadbased basis, however, that is part of the price you pay. We have no reason to believe that El Pomar is doing anything improperly. It is simply a matter of treating all private foundations on a fair basis. Senator ARMSTRONG. I understand. One last question. You state that extensive private foundation ownership of business raised a number of problems, and one of them that you point out is "a business that is owned by a tax exempt entity often has a competitive advantage over a similar business owned by taxable persons." Again, I would want to state for the record that I acknowledge that in many cases this may have been true. We do not think it is true in the case of El Pomar. I am assured that it is not by the responsible officials of El Pomar. And, in fact, they will be testifying later today and I shall again put that question to them. But for the record, does the Treasury have any reason to think that this objection applies specifically to El Pomar? Mr. PEARLMAN. No, we do not believe so, Mr. Chairman. Senator ARMSTRONG. Well, I am very grateful to you for coming and we look forward to seeing you this afternoon. Mr. PEARLMAN. Thank you. Senator ARMSTRONG. Thank you very much. The committee is now very much pleased to bring forward a panel consisting of Mr. Herbert J. Lerner, chairman of the tax policy subcommittee of the American Institute of Certified Public Accounts; Mr. Greg Johnson, director of the United States Business and Industrial Council of Washington, D.C.; and Mark Bloomfield, director of the American Council of Capital Formation, Washington, D.C. All three are authorities and experts who are well known to the committee and to the Senate, old friends of mine, and I am grateful to have them here. And we are very pleased to have this opportunity to hear your testimony. I believe that it is your intention to testify on S. 1600, the Capital Gains Indexing Provision. I would like to ask that we hear all three of the witnesses and then I will have some questions. First, Mr. Lerner, would you proceed and give us your testimony on this legislation? STATEMENT OF HERBERT J. LERNER, CHAIRMAN, TAX POLICY SUBCOMMITTEE, AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS, WASHINGTON, D.C. Mr. LERNER. Thank you very much, Mr. Chairman. My name is Herbert J. Lerner, and I am the chairman of the Tax Policy Subcommittee of the Federal Tax Division of the American Institute of CPS's. I am pleased to appear here today to support Senator Armstrong's indexation bill, S. 1600. My comments reflect the views of the AICPA, which represents approximately 200,000 certified public accountants throughout the United States. In their practices, CPA's apply the tax laws to a myriad of real life situations. In addition to observing the practical effects of these laws, we believe that we have a responsibility to try to help improve the tax system. In order to do so, periodicially we publish statements of tax policy which provide our perspective and analysis of major national tax policy issues. One such issue was addressed in our tax policy statement No. 9, entitled "Implementing Indexation of the Tax Laws," a copy of which is appended to my statement for inclusion in the record. Mr. Chairman, your indexation bill is generally consistent with the recommendations of our statement, in that it provides for the indexation of the basis of assets to minimize the impact of inflation on the tax system. Your bill, coupled with the 1985 indexation of tax rates, the zero bracket, and personal exemptions, as enacted by ERTA in 1981, represents an important step toward comprehensive indexation and resulting greater equity in our system. The 1981 act changes represented a major endorsement by the Congress of the concept of indexation of our system as it relates to the individual income tax, and I wish to reaffirm our support for those changes which become effective in 1985. But the 1981 act changes are limited to indexation of tax rates, not indexation of the tax base. It will eliminate the concerns about bracket creep for most individuals who derive their income from inflated rates of current salaries, wages, and so on. But the 1981 act will have limited effect on those who derive inflation-induced gains from the sale of an asset held for many years. The individual who derives gain from such a sale in 1985 may or may not be affected by the rate bracket adjustments, if any, for that year, and it would only be co incidental if the rate bracket adjustment bore any relationship to the distortion of real income realized on the sale of the property. The 1985 indexation of rates only serves to preserve the rate structure established for 1984 by avoiding inflation induced changes. It does not attack the fundamental issue of how to protect individuals from taxation when there has only been nominal gain realized due to prior inflationary years. Indexation of the tax basis of property is, we believe, the solution to that problem. Some have argued that the indexation of basis is not necessary because of the 60-percent exclusion of long-term capital gains from taxable income. We believe that the current or any such similar exclusion is neither an equitable nor an adequate method of compensating for inflation. Despite the exclusion, taxpayers who have suffered a real economic loss often are subject to tax from the sale of an asset. A simple example will illustrate this point. A 9-percent nominal gain on the sale or exchange of an asset held for more than 1 year during which time inflation was 10 percent, will result in an economic loss of 1 percent. Under our present tax structure, however, the taxpayer would be required to pay tax as if a 3.6-percent taxable gain-that is, 40 percent of the 9 percent-had actually been realized. The inequity of that result is apparent. Indexing the tax basis of assets for gain or loss, or for cost recovery purposes, need not be unduly complex. The unadjusted basis of each asset would be multiplied by a factor which would establish the newly calculated indexed basis to be used for purposes of determining gain or loss on the disposition. The use of an indexed basis would result in the calculation of gain or loss on the sale of assets that would be consistent with the underlying economic effect. In the interest of tax simplification, however, index factors might be determined on an annual basis rather than on a quarterly basis as proposed. Although excluded from S. 1600, we believe that indexation also should apply to tangible personal property and to the basis of assets for calculating depreciation. Depreciation charges based on unadjusted historical cost are unrealistic when they are compared with current replacement cost. Under an indexed system of depreciation, the accelerated cost recovery percentage could be applied to the indexed basis to calculate the taxpayer's depreciation deduction. Besides current tax rules pertaining to depreciation, new ones could be applied. The system of open-ended or pooled accounts, with which several of the members of this committee are familiar, is particularly well suited to indexation. Furthermore, the indexation of basis need not affect the determination of the period over which capital costs would be recovered. While use of an indexed basis for calculating depreciation would make it possible to recover more than 100 percent of the original cost through depreciation deductions, it would reflect economic reality and aid investors in dealing with the rising replacement costs of capital assets during inflationary periods. I call this subcommittee's attention to the other indexation recommendations contained in our tax policy statement. For example, our statement also recommends that all fixed-dollar allowances or exemptions in the Code should be indexed to avoid the unlegislated erosion of the value of those provisions when they were enacted. We see indexation of the tax code-both the rate structure and the base-as essential ingredients to an improved, more equitable, tax system. There are a number of other policy and technical issues under S. 1600 that deserve further consideration by this committee and its staff, and the AICPA Federal Tax Division is prepared to work with you and the staff in the effort to address those issues, including some of the points raised by Mr. Pearlman of the Treasury Department. We welcome the opportunity to do so. Thank you. Senator ARMSTRONG. Thank you very much. I have some questions which I will come back to you after we have heard from the other witnesses. Next, Mr. Jonsson, from the U.S. Business and Industrial Council of Washington, D.C. [The prepared statement of Mr. Lerner follows:] |