Newman’s Own Says Tax Law Will Burn Them, But Their Arguments Lack Pop

Ever since Paul Newman rode off to face the great Bolivian army in the sky, his heirs have been cooking up a legislative scheme to repeal a long-standing and important tax provision. The rule in question is the obscure-sounding “excess business holdings” rule, TC 4943. Under that rule, private foundations (like the one that now holds a tasty 100% of the Newman’s Own line of products) are prohibited from owning more than twenty percent of any firm, although the foundation gets a few years to divest fully. Bloomberg reports that several senators, at the behest of the Newmans Foundation, have introduced versions of a bill that would gut the EBH rule. These bills should get moved to the back burner, and shame on Newmans for prioritizing the interests of the Newman heirs over good philanthropy.

At first glance, the Newmans bills seem innocuous. They allow foundations to hold unlimited shares of a business, as long as all the net profits of that business are donated to charity. Who could complain about that?

You should. The bills are a bad deal for taxpayers, a net loser for philanthropy, and costly for the economy overall. So who wins? Heirs who have a personal stake in the reputation of the firm with their name and their dad’s picture on it.

To see why the EBH rule is so useful, consider the alternative. Instead of keeping control of Newman’s Own, making profits, and then moving those profits to the foundation, suppose the Newman Foundation instead sold Newman’s Own, then used the proceeds to invest in a diversified portfolio of investments.

Consumers, and in the long run the U.S. economy, would be big winners if Newman’s Own were sold. As Jon Klick and Rob Sitkoff have shown with their study of the Milton Hershey School, philanthropic organizations are terrible at running businesses. Sheltered from almost every device that for-profit managers usually face to maximize consumer satisfaction and make the most of the assets at their disposal, foundation managers in effect squander what could be a much more valuable property.

The Foundation benefits, too, because being invested in just one asset is a bad long-run bet. Hey, maybe people will still pay a premium for salad dressing when they no longer can remember how much they liked ol’ blue eyes. But maybe not. And if Newman’s Own craters, so does the foundation.

The counter-argument, I guess, is that if Newman’s Own is sold, we’ll lose out on all the dollars for charity that its future profits would have generated.

That’s wrong in a few different ways. For one, by definition the value of Newman’s Own stock represents the present discounted value of its future profits. And, as Klick & Sitkoff showed, probably the expected value of those future profits will skyrocket if the business is taken out of the hands of the foundation). So, in present-value terms, taxpayers lose nothing if Newman’s Own is sold, and probably gain considerably. On top of that, by swapping out the Newman’s Own revenue stream with a more diversified portfolio of income-generating investments, the government, too, gets the benefits of diversification. So, in risk-adjusted terms, us taxpayers are big gainers when Newman’s sells.

Finally, letting the Newman Foundation keep control of Newman’s Own (and letting any future, similar, foundation keep their respective family-owned businesses) is bad tax policy in yet another sense. We shouldn’t give people tax breaks for doing things they would do anyway. For that reason, you’re not generally allowed a charitable contribution deduction when your “contributed” money is actually being used to buy something you value. The Newman heirs obviously value the right to control Paul’s legacy (not to mention the right to hire the folks who will manage the company).

Famously, the excess business holdings rule was a response to the Ford family, which “donated” control of Ford to the Ford Foundation, then used their control of the Foundation to maintain control of Ford Motor Company — -indeed, people named Ford still sit in the CEO seat of Ford to this day. You shouldn’t get a tax deduction for “donating” your family firm, if you are still using the firm to further your own family’s interests.

*A Correction (8/20/16): Since taxpayers are “invested” in many foundations, they get the benefits of diversification even if each individual foundation retains only a single asset.