TAX-EXEMPT ORGANIZATIONS

Lewis E. Harris, president, Harris Laboratories, Inc., Lincoln, Nebr.

My name is Lewis E. Harris. I am president of Harris Laboratories, Inc., an independent, taxpaying, research and testing laboratory located at Lincoln, Nebr. I am serving as a representative of and spokesman for the American Council of Independent Laboratories which is an organization comprised of 80 of the leading independent, taxpaying laboratories in the United States. These laboratories are located in all major cities and several of them operate branch laboratories. They provide services covering nearly every scientific need of industry and Government. I am chairman of the Committee on Legislation and Tax-Favored Competition of the American Council of Independent Laboratories.

This statement refers to the section on "Tax Exempt Organizations" in the study by the Committee on Ways and Means on opportunities for constructive reform of the Federal income tax. In this statement I will direct attention primarily to the improper tax exempt status and unintended tax benefits now enjoyed by the so-called nonprofit research institutes.

I expect to show that such nonprofit research institutes are operating outright commercial businesses in applied research and testing services, that only a small amount of the work done by such institutes is made available to the public, that their activities are not in accord with their charters and with the functions for which they were originally granted tax-exempt status, and that they are depriving the Government of large amounts of tax moneys.

I will show that science has now developed into a mature and great industry where it can easily stand alone the same as the chemical, pharmaceutical, steel, and other industries, that applied research and testing service is a professional business service the same as medicine, law, and accounting.

Evidence will be presented to support the statement that these socalled nonprofit research institutes do operate multimillion-dollar businesses at a profit, that they have had tremendous growth at the expense of the taxpayer, that they do not serve a public function in any substantial way, and that the elimination of this improper tax-exempt status will result in materially broadening the incometax base and aid in the development of lower rates. I will show that proper taxation of such income from the applied research and testing businesses conducted by research institutes will in no way interfere with or curtail the scientific progress of our country. Indeed, such proper taxation on applied research may well be one of the pressures needed to force more attention to truly basic research which is sorely needed to assure our scientific status on a worldwide basis.

HISTORICAL AND GENERAL DATA

Research institutes have been established from time to time over a period of more than 40 years. Some were created by individuals who wanted to do something of value in the public service, others have been organized by persons as outright promotional functions; a few have been set up with direct or indirect affiliation with some university. In nearly every case those who manage such institutes utilize the technique of naming influential business and professional men on advisory boards or panels so that their tacit approval and support of policies and actions might lend dignity, prestige, and promotion. It seems doubtful that many of these board or panel members are correctly advised of actual functions or clearly understand the policies of such institutes. Curiously enough, a businessman will object strongly to unfair, tax-favored competition in his own industry, but may blindly support such tax-favored competition in another area.

So-called nonprofit research institutes were created with very noble purposes under tax-exempt charters. In most instances it was planned they would carry out basic research for the good of the public or they would conduct research on development of new products with results freely available to all. On this basis these institutes were properly granted Federal tax exemption, as well as State, county, and municipal tax exemption in many cases.

Almost without exception, these institutes immediately went into the business of applied research, with little attenion to their original purpose of basic research for the public good. The institutes have continued to devote the majority of their time, effort, and attention to applied research sponsored by industry and branches of government, with results of such work held confidential and available only to the sponsor. In many cases this applied research has resulted in patents which are always assigned to the industrial sponsor. Is this activity a public service which should be rewarded with tax exemption? Activities of so-called nonprofit research institutes

One needs only to read the elaborate promotional brochures or contracts of these institutes to clearly understand that they are primarily interested in applied research business, that they will protect an industrial sponsor's interest in any project, and that they will agree to keep results of such work confidential with any patentable product, process, or use being assigned exclusively to such sponsor.

The assistant director of one of the large research institutes, in an address which was reprinted, quoted a satisfied client of his institute as saying:

A unique feature of the services offered by these agencies lies in the exclusivity of their relation to a sponsor. Not only do they honor the confidence that must of necessity exist between their staff and the sponsor, but to insure that a satisfactory atmosphere will be maintained, only one sponsor in a particular field will be admitted. The laboratories' work in this field, therefore, is available to him exclusively. This includes delivery to him of patent rights resulting from their work for him, control over the publication or dissemination of papers, data, or even reference to the nature of the work being performed for him. This research institute official concludes:

I believe you will find these comments are typical of those who work regularly with contract research organizations.

This perversion of the institute privileged status was brought out most forceably in "Research and Development by Nonprofit Research Institutes and Commercial Laboratories." It was published by the National Science Foundation, compiled by a group at Syracuse University, and may be obtained from the U.S. Government Printing Office. This survey shows conclusively that research institutes devote only 6 percent of their activities to basic research or research for public good.

The 94 percent is in the field of applied research, sponsored largely by industry or by a branch of Government, with results of such research and patents supplied only to the sponsor. Very little of the 94 percent could be classed as "for the good of the public." Yet, strangely enough, these institutes operate profitable businesses at public expense. For any tax-exempt or tax-favored business operation simply narrows the tax base and results in higher taxes for each taxpayer.

Some of these tax-favored institute business operations advertise openly in newspapers that their services are available to industry. Some have outside technical salesmen and public relation experts. Others carry on sales promotion programs, occasionally disguised as seminars or conferences. They are in the business of selling applied research. They issue expensive annual reports and elaborate promotional brochures which shame those of multimillion dollar corporations.

Authentic information is available to show that at least one of the larger institutes actively bids on routine testing work in direct competition to taxpaying laboratories offering exactly the same services. This institute regularly carries on an active testing business in continuous competition to taxpaying laboratories.

Growth of research institutes

Research institutes have, of course, enjoyed tremendous and rapid growth during the past few years. One report indicates that Southwest Research Institute has increased its staff from 10 to 440 and its sales from zero to $42 million in 10 years. Stanford Research Institute is said to have sales exceeding $18 million in 1958, a 20percent increase over 1957. These appear to be typical of the rapid expansion in all these tax-exempt institutes. Such growth is to be expected, of course, in any business which enjoys a tax-favored position.

The September 12, 1959, issue of Business Week carries an article. on "Nonprofit Labs Carve Big Niche." This is recommended reading for it outlines very well the commercial and business operation of research institutes. It is reported that seven of these tax-free organizations will do over an estimated 100 million dollars' worth of applied research and testing business in 1959. This represents only part of the total dollar business volume since no data is available from the many other institutes not included in this estimate. Further, the applied research and testing businesses operated by certain departments of many colleges and universities would swell this total of taxexempt business into several hundred million dollars.

Research institutes do make a profit

There can be no doubt that research institutes do make a profit although accounting systems may frequently divert attention from this by use of other terminology.

It is reported (Business Week, Sept. 12, 1959) that Stanford Research Institute plans to invest over $10 million in new buildings during the next decade with financing partly out of surplus earnings and the balance through mortgages. An earlier publication indicated "Stanford Research Institute has amassed $1.6 million for its equipment fund." Corporations and other businesses cannot deduct expenditures for equipment as operating expenses, and these can only be depreciated over a period of years. But we have here a taxexempt business easily piling up $1.6 million out of tax-free profits, and they can then purchase equipment and charge it off immediately as a cost of doing business. This same report went on to say that a client is billed on this basis: "The cost of salaries plus the overhead, plus expenses, plus 12 percent." It should be stressed that this 12 percent tax-free figure represents a tremendously fine profit for any kind of business.

Two years ago Cornell Laboratories, a subsidiary of Cornell University, reported they had conducted $75 million worth of applied research business in 11 years, and a Wall Street Journal article said this about them:

Although it is a profitmaking corporation, it does not pay taxes, because it is part of an educational institution. Mr. Ross, its manager says, its earnings are used to add new facilities and support fellowships. In its fiscal year, ended June 30, the laboratory netted with no taxes, $429,000 on a gross of $13 million.

Armour Research Foundation in 1955–56 did a business of nearly $12 million, largely applied business research, 12 percent more than the previous year. Their own publication indicates that in 1957 they had 619 projects of which 13, or less than 2 percent, were concerned with basic research. The other 98 percent of those research projects were pure business research items, the results of which were maintained in a confidential manner, and any patents were assigned to the sponsor.

Business Week described profitmaking functions of institutes very adequately in their September 12, 1959, issue when they reported "* * * But as jobs began to pay off, they were able to plow back profits into more facilities. * * *”

66*

The above are typical examples of the definite profitmaking aspect of research institute business. There can be no doubt that each of them makes a very fine profit although such profit is frequently designated as "surplus," "reserve," etc. The tremendous increases which institutes have made in facilities and equipment had to be paid from some kind of funds. Either these expansion funds came from profits or the institutes have developed an undisclosed method for creating money out of hot air.

Competitive problems created by institutes

The institutes are in direct competition with independent, taxpaying laboratories and create a serious, unfair competitive problem. These tax-exempt institutes frequently point out that they have available very large, very expensive or unusual equipment for certain research and testing operations. They use this as a base for argument

that their possession of such equipment or facilities justifies their providing such professional business service to industry and Government since no independent taxpaying laboratory can provide the necessary service. This argument is without foundation and is based on a false philosophy.

There are many reasons why this specialized equipment may be available only at institutes or universities. First, the independent laboratory must acquire such equipment with any profit remaining after the payment of all types of taxes, as compared to the ability of an institute to use tax-free profits for such purchases; second, under our tax laws the independent laboratory cannot receive tax-free gifts of equipment or funds for equipment while the institute may acquire such gifts or funds tax free; third, the taxpaying laboratory must advance risk capital for equipment in contrast to no risk on the part of an institute which is subsidized by gifts, endowments, subscriptions, fellowships, and other arrangements. All of this simply adds to the unfair competitive picture since the institute can thus acquire equipment and facilities which preclude the possibility of the independent laboratory ever being able to enter the field in a competitive manner. These unfair competitive practices form the base and excuse for further expansion of such institute facilities since they can claim that independent laboratories have been unable to supply the service. Other unfair competitive problems have resulted in numerous cases where institutes have deliberately entered into fields already adequately served by independent laboratories. In some areas the institute has openly bid on routine testing work in direct competition with the taxpaying laboratory. In some cases there is evidence in which it appears that an institute has deliberately reduced fees in an effort to eliminate competition and at the same time has increased overhead cost factors on cost-plus contracts with Government agencies to recover such losses.

Most institutes are originally established with the stated purpose of serving the public in a given State or a certain area; however, many of them are so eager to expand and increase their sales that they immediately solicit business on a national and international scale. Several of these have found it necessary to establish branch operations in other States to handle applied research or testing contracts even though local taxpaying facilities were available to supply the same services. Indeed, a few institutes have become so aggressive that they have established foreign offices to expand their business. services. If the research institutes are really nonprofit, why are they so anxious to expand their operations into such remote places?

We have thus reviewed a few of the unfair competitive situations which are created by the institutes. Their tax-exempt status creates a serious threat to the continued existence of the independent laboratory, and their system tends to stifle competition and narrow the tax. base. This would be an interesting area for investigation by the Federal Trade Commission and the U.S. Attorney General. The term "independent"

The taxpaying laboratories have used the term "independent" in its proper sense for many years to correctly describe their status and. indicate complete independence from any kind of subsidy, connection with a university or Government agency, or tax-favored arrangement.

47060-59-pt. 337