Senator ARMSTRONG. In other words, the whole amount of the airline trip.

Mr. PEARLMAN. Again, assuming that it can be demonstrated that the entire trip was a charitable trip and that it was not a day in a meeting and a week of sightseeing, then yes.

Senator ARMSTRONG. I understand. It has to be for a legitimate purpose.

Mr. PEARLMAN. Right. Then the entire cost may be deducted.
Senator ARMSTRONG. Hotel expenses, too?

Mr. PEALMAN. Hotel expenses and any out-of-pocket costs relating to that charitable activity. That is correct.

Senator ARMSTRONG. Well again, I just must note that there is a substantial fairness issue that I think that the committee will want to look at.

I would like to now turn to your testimony with respect to the El Pomar legislation. You made a point of saying that this legislation, S. 1464, is intended to exempt El Pomar Foundation from the foundation divestiture requirement. And I don't think I heard you say any more than that. I wouldn't want any misunderstanding though. The drafters of the legislation believe that it exempts El Pomar and no one else. Does the Treasury have any different thoughts than that?

Mr. PEARLMAN. We were under the impression that there might be some other foundations that might be exempted, but I think it is always the risk of having a bunch of foundations out there and not knowing the facts relating to each of them. But, no, I did not mean to imply that we were aware of other specific foundations. [The following was received for the record:]

Dear Senator Armstrong:

This letter is in response to questions you asked relating to the El Pomar Foundation during the August 1 hearing on S. 1464.

Bettim 18

You asked whether S. 1464 would exempt any foundation other than the El Pomar Foundation from the excess business holdings rules. Neither the Treasury Department nor the Internal Revenue Service is aware of any other foundation that would qualify for the exemption provided by S. 1464. However, we do not routinely collect information that would permit us to determine whether another foundation exists that would be described by the provisions of S. 1464. Therefore, we are unable to state categorically that the El Pomar Foundation would be the only foundation exempted from the excess business holdings rules by S. 1464.

You also asked whether the Treasury Department has any reason to think that any of the abuses at which the excess business holdings legislation was directed exist with respect to the El Pomar Foundation. We have no specific information indicating that the El Pomar Foundation's ownership of the Broadmoor Hotel involves any abuses. However, a determination that none of the problems associated with excess business holdings exist in connection with the El Pomar Foundation's ownership of the Broadmoor Hotel would require a detailed investigation of the operations of the Foundation and the hotel. For example, one of the concerns addressed by the excess business holdings rules was that a private foundation might not demand the same rate of return from a business as that demanded by a taxable owner. Permitting a business to earn an unusually low rate of return or to retain an unusually high proportion of earnings may reduce or delay the benefits going to charity and provide the business with a competitive advantage over businesses owned by taxable persons. The determination of whether the El Pomar Foundation is operating the Broadmoor Hotel in a manner that provides the full benefit of the investment to charity and that is not unfair to competitors would require a review of the hotel's operations, a comparison to the operations of hotels owned by taxable persons, and consideration of the benefits that might go to charity if alternative investments were made with the Foundation's assets.

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.

The Honorable

William L. Armstrong
United States Senate
Washington, D.C.

20510

Sincerely,

Rowald Weat

Ronald A. Pearlman Deputy Assistant Secretary (Tax Policy)

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