funds have increasingly become important sources of capital for investment in the private sector. Before any further limitations are placed on deferred compensation plans, considerable study should be given to the effect of such limitations upon this pool of investment capital. I therefore endorse the request of Secretary Kennedy that changes in deferred compensation plans proposed in Section 331 as well as in Section 541 (referring to subchapter S corporations) be dropped from the bill for further study. Finally, I am concerned about proposed changes in present capital gains treatment of income from the sale of livestock. Lengthening the required holding period and including livestock in the depreciation recapture rule could create considerable havoc in an industry already beleaguered with economic problems. Here, as in the case of foundations, we must avoid penalizing the vast number of legitimate operations to reach alleged abuses by a small number of taxpayers. Mr. Chairman, in conclusion, I wish to congratulate you and this Committee and its staff for the intensive scrutiny you are giving to this massive bill and the hospitality you have shown to all witnesses. I look forward to working with you toward the enactment of tax reform legislation which will promote the interests of tax equity and our national economic health. # # # Statement on H. R. 13270 Senate Committee on Finance October 2, 1969 Dan Throop Smith For Release on Delivery Mr. Chairman and Members of the Senate Committee on Finance: It is a pleasure and honor to have this opportunity to appear before you with reference to H.R. 13270 which would make the most extensive revisions in the tax laws since the adoption of the Internal Revenue Code of 1954. Many of the substantive revisions are long overdue. They will prevent abuses which have developed under the letter of the existing law but seem rather clearly to flout its spirit and the intent of the Congress. In that category, one may readily include the Clay-Brown provisions and the extension of the unrelated business income tax to the exempt organizations to which it does not yet apply; the tighter rules on farm and hobby losses; the prevention of tax benefits through a proliferation of multiple corporations; the tighter rules for taxation of cooperatives; the recapture of depreciation on real estate; the rules for peculiar forms of stock dividends and separate classes of common stock and the proposed limitations on certain aspects of mergers, which are discussed subsequently. The reasons for the foregoing changes are all well stated in the Report of the House Committee on Ways and Means. Other substantive provisions represent new departures, some of which seem unduly complicated and questionable from the standpoint of economic or social policy. State and Municipal Bond Interest The proposal for an option to states and localities to issue taxable bonds, with a Federal interest subsidy which would more than offset the higher interest costs, is the best approach thus far devised to deal with a problem which each year becomes more perverse in its effects. The issues of state and local bonds have become so large that they can be absorbed only by offering yields which do not reflect their tax advantage to most holders. The interest savings to borrowers are far less than the revenue losses to the Federal government; under the proposed new procedure both levels of government would be better off, a distorting element in the flow of investment funds would be removed and the highest-bracket taxpayers would no longer have an opportunity for a large intra marginal tax benefit. But any change in the treatment of municipal taxes should be made only with respect to future issues. The inclusion of municipal bond interest in the limit on tax preferences would be a form of retroactive legislation. And it has already disturbed the bond market. The Treasury recommendation to remove this item from the limitation on tax preferences should be accepted the better for our hard-pressed state and local governments. Private Foundations and the sooner As regards private foundations, the prohibitions on self-dealing seem thoroughly reasonable and desirable. There have been significant abuses and the proposed constraints would not appear to hamper any reasonable objectives of foundations. The same statement seems valid with respect to the limitation on stock ownership and the use of assets, though a long period should be allowed for divestment. It should also be recognized that in a good many cases companies in which foundations hold a large interest will become vulnerable to raids by other corporations seeking mergers. The imposition of a tax on investment income, by contrast, seems to be an undesirable and uncalled for penalty. Tax-exempt charitable and educational organizations have been a source of real strength in our society and their continued activity will help to maintain diversity in areas where there is danger of excessive uniformity through expanded government programs. Once adopted, the applicable tax rate is likely to be increased as a response to unpopular programs financed by one or a few foundations, thereby depleting the strength of all foundations. It would be much more desirable to impose necessary restrictions directly as is done in other parts of the applicable sections and to confine any tax to a fee sufficient to cover the costs of administering returns of tax-exempt foundations as has been proposed by the Treasury. Furthermore the line of demarcation between permitted and forbidden activities concerning legislation is too vague and would almost certainly prevent outlays on such important subjects as the population explosion and the prevention of further pollution of the environment. Some constraints are necessary, especially those related to expenditures for a particular candidate or selective voter registration, but revision in the statutory language or some very strong and clear examples of exemptions in the Committee Reports seem necessary if the country is not to lose the benefit of leadership of foundations in dealing with social problems which almost inevitably involve legislation of one sort or another. Specifically, the prohibition of expenditures "to carry out propaganda, or otherwise attempt to influence legislation" in section 4945 (b) (1), described further as "any attempt to influence legislation through an attempt to affect the opinion of the general public or any segment thereof" in section 4945 (c) is much too comprehensive. I repeat for emphasis that programs to alert the general public to the problems of the population explosion and the pollution of our environment would appear to be ruled out. Governments have been very slow to develop their own programs in these two most vital areas; society needs all the leadership and education it can get on subjects such as these, and tax legislation which prevents bold action would be little short of tragic. Restricted Property Options in restricted stock will probably not be used to any appreciable extent in the future if the proposed changes in their tax treatment are adopted. Options in this type of stock have developed in recent years to circumvent some of the limitations imposed on qualified stock options which are given special favorable treatment in the tax law. Since options in restricted stock may be used to secure more favorable tax treatment, it is not unreasonable that their value should be taxed fully as ordinary income. Though the subject of options is controversial, there is a good deal to be said for long-term stock ownership by management in the companies for which they are responsible. Unfortunately, stock options have too frequently been abused, with quick sales as soon as stock qualifies for capital gains treatment. The present law on qualified stock options might well require a longer holding period and permit a longer period for options to run before exercise. But the maximum marginal tax rate of 50 percent on earned income will significantly change the relative attraction of options and cash compensation for both executives and corporations in favor of cash compensation. The use of options of all sorts will probably decrease in any case, and the new provisions on options in restricted stock will turn out to be relatively unimportant. Deferred Compensation The 50 percent maximum marginal rate on earned income will also very substantially reduce the advantages of deferred compensation contracts. The difference in the tax rate applicable to pre-retirement and post-retirement income will be much less for executives with large salaries, and they will tend to find that the advantage of immediate receipt of income, with opportunities for immediate investment, will outweigh the advantages of postponed receipt for relatively minor tax differentials. Thus the use of deferred compensation contracts may be expected to diminish considerably. |