The Tax Reform Act of 1969

In the early 1960s, the seemingly irresistible force met the truly immovable object. As Thomas A. Troyer recounts in “The Cataclysm of Sixty-Nine” (1999), Rep. Wright Patman (D-Tex.), a populist down to his socks, was hearing disturbing reports about underhanded doings at foundations, some of which were located in a region of the country he found highly suspect (the Eastern seaboard). In 1961, Patman requested a broad range of data from more than five hundred foundations. He was furious about the abuses his survey uncovered—a tiny percentage of his sample, to be sure, but probably, he suspected, only the tip of the iceberg. Among the findings were foundations that paid out little or nothing for charitable purposes, foundations used to enrich the donor and the donor's family and friends, and foundations formed not for philanthropic purposes but to avoid payment of taxes. Only a handful of foundations were involved, some of which had multiple problems. The vast majority operated efficiently and honestly, but Patman focused on the feckless few.

In 1962, Patman launched what was to become an ongoing campaign against foundations. In that year, he called on the Internal Revenue Service to suspend issuance of tax exemption rulings to all foundations. Every few months thereafter for the next six years, Patman convened hearings, fired off press releases, and issued reports on his latest concerns about foundations. Patman was soon joined by Senator Albert Gore Sr. (D-Tenn.), whose son Albert Jr. would later become vice president of the United States. They jointly proposed that a twenty-five-year limit be placed on the life of all foundations.

By 1964, Patman and Gore's steady drumbeat threatened to derail the Tax Reform Act of 1964, then pending in the Senate Finance Committee. To prevent that, Secretary of the Treasury Douglas Dillon promised to conduct a comprehensive survey on foundations and report to the Finance Committee. Dillon, a former investment banker with a good understanding of the foundation field, appointed an advisory committee, which helped the Treasury Department survey a sample of thirteen hundred foundations, including all of those with assets of $10 million or more, and which gathered information from other sources as well. A young treasury staffer named Thomas A. Troyer drafted most of the report, which offered high praise for the work of most private foundations. The report did, however, document many of the abuses alleged by Patman, but found that these transgressions had been committed by a small minority of the foundations studied. The report recommended remedies including laws to curtail self-dealing, establish minimum payout requirements, and place limits on how much of a for-profit enterprise a foundation could own (U.S. Treasury, 1965).

The treasury report stopped the Patman-Gore juggernaut in its tracks. Their proposed twenty-five-year limit on the life span of foundations went down to defeat, and the Tax Reform Act of 1964 proceeded on schedule. The two lawmakers were down but not out, however. They attacked the “soft on foundations” stance of the report and redoubled their efforts to shackle foundations with legal irons. Patman and Gore found their opportunity in the issue of tax loopholes. It was unfortunately true that a small number of foundations had been formed strictly as a means of evading income and other taxes. In January 1969, the secretary of the treasury reported on some examples of loopholes. The House Ways and Means Committee promptly launched hearings on tax reform, and foundation leaders were called as witnesses. For the most part, these CEOs were largely unsophisticated in the ways of congressional testimony, and their artlessness only made matters worse. Ironically, the foundation leader who was intimately familiar with the ways of Congress, former Kennedy administration aide and then Ford Foundation president McGeorge Bundy, adopted a combative tone for his full day of testimony and alienated key members of the committee. After a long week in the witness chair, foundations were depressed, on the defensive, and lacking a plan to recover the ground they had lost.

The mood of doom, defeat, and despair intensified in late May, when the Ways and Means Committee introduced punitive legislation that would restrict the types of grants that foundations could make, deny tax advantages for contributions to them, and slap them with a 5 percent excise tax on investment income. This news caused the larger foundations to finally mobilize behind their “trade association,” the Council on Foundations (established in 1949), to launch a counterattack. As the legislation moved from the House to the Senate, foundation leaders concentrated their fire on the upper house of Congress. They called supportive witnesses from nonprofits, including Dr. Jonas Salk, to testify about their good works. They found champions in the Senate, including Walter Mondale (D-Minn.), who led the fight for them on the floor. The counterattack worked; the Senate version of the bill greatly reduced the programmatic restrictions imposed by the House bill, liberalized the treatment of donations to foundations, and slashed the proposed excise tax rate.

Unfortunately for foundations, a key member of the House-Senate Conference Committee convened to reconcile the two bills was Rep. Wilbur Mills (D-Ark.), the House member second only to Patman in his distaste for foundations. Mills exerted his considerable clout to make sure the Tax Reform Act of 1969 that emerged from the Conference Committee looked much more like the House version than the Senate version of the bill. The act placed restrictions on fellowship programs and voter registration drives. It made charitable deductions for gifts to private foundations less attractive than those to public charities. It placed restrictions on self-dealing and on the percentage of a business a foundation could own. Most disturbing, it set the excise tax for foundations at 4 percent, and the payout rate at 6 percent of asset value or all of net income, whichever was greater. In addition, the legislation allowed the treasury to use its discretion to raise or lower the payout rate as desired.

The Tax Reform Act of 1969 fell like a bomb among foundations. The rate of new foundation formation dropped precipitously. Several existing private foundations terminated their existence, passing their assets to community foundations or public charities. Most foundations that remained realized that the one-two punch of a 4 percent excise tax and a 6 percent payout rate, combined with legitimate administrative expenses, would create a yearly demand that their endowment could not meet. Hence it was clear that over time their corpus would inevitably erode, and eventually the foundation itself would cease to exist.

The Council on Foundations, however, took a different view. As the council's leaders examined the 1969 act, they decided that some of its provisions, especially the prohibitions against self-dealing and excessive business holdings, were actually needed reforms. The programmatic restrictions were more annoying than alarming. The only truly dangerous provisions were the excise tax and the payout rate, both of which had been set too high. If these could be rolled back, foundations could live quite comfortably with the changes wrought in 1969. The council, under the leadership of David Freeman, set about building a capacity in foundations to do public policy work. This took some time, but the council and its members quite effectively enhanced their capabilities in this vital arena.

In 1976, when the treasury adjusted the payout rate upward to 6.75 percent, the council and its member foundations flexed their new policy muscles and were able to convince Congress to reduce the rate to a flat 5 percent of net asset value. Heartened by this victory, the council redoubled its efforts, and in 1978, it succeeded in getting Congress to cut the 4 percent excise tax in half. In 1981, Congress repealed the bothersome rule that required foundations to pay out all of their income if it exceeded 5 percent of net asset value. Finally, in 1984, Congress passed a law containing a formula allowing foundations that could meet certain requirements to cut their excise tax from 2 percent to 1 percent.

The immediate effect of these victories, of course, was to stop the erosion of foundation endowments. The repeal of the more punitive aspects of the Tax Reform Act of 1969, combined with the big bull stock market that began in 1982, resulted in the foundation birthrate taking a sharp turn upward. The 1980s surpassed the 1950s as the best decade ever for foundation formation.

On balance, then, the Tax Reform Act of 1969 proved beneficial to foundations. As Troyer (1999) has written, “Profoundly traumatic as it appeared at the time, the act rid the field of abuses that undercut philanthropic goals, that were, sooner or later, bound to precipitate Congressional action.” To be sure, the act contained some burdensome and unwise provisions, but nearly all of these have been corrected by subsequent legislation or regulation. The Tax Reform Act of 1969 set the stage for the foundation field as we know it today, and for these reasons, surprisingly enough, there should be a framed picture of Wright Patman hanging in every foundation boardroom in the country.