WASHINGTON 8/25/2015
Should College Endowments Be
Taxed?
Howard Gleckman
Last week, the oftenprovocative Victor Fleischer rocked the higher
education world with a New York Times oped that accused universities of
hoarding their oftenenormous endowments instead of spending the funds
on student aid.
Vic, a tax law professor at the University of San Diego, suggested that
colleges be required to spend at least 8 percent of their endowments each
year. But he could have asked a more fundamental question: Why are these
funds taxexempt at all.
There is no doubt that taxexempt status is enormously beneficial to
universities. They are exempt from local, state, and federal income taxes.
They are exempt from property taxes, even as they receive an estimated $80
billion in support from state and local governments, according to a study by
the Nexus Research & Policy Center. Some schools do make voluntary
payments in lieu of property taxes, but many do not.
Even their nonacademic income, from the sale of everything from football
skyboxes to tee shirts and computers, is often taxfree (though in theory the
law requires them to pay tax on this unrelated business income). Thanks to
their special status, universities often finance capital projects with taxexempt
bonds.
Not only are gifts from wellheeled alumni deductible to the givers, but
investment earnings on the cash hoards are taxexempt. These endowments
are enormous, topping $500 billion according to one estimate. And they are
highly concentrated. In 2014, the top 10 schools held nearly onethird of
those assets.
The Nexus study found enormous variation in the perstudent value of these
subsidies. For instance, it calculated that the average perstudent subsidy at
private, highendowment schools was more than $41,000 but barely $5,000
at community colleges. In New Jersey, compare Princeton’s per student
subsidy of $105,000 with Rider University’s $500.
The study took into account some direct payments to schools and grants to
students. It excluded research grants and property tax exemptions. It also
assumed that all increases in the value of endowment assets were taxable
gains though current law taxes only realized gains.
The funds are often aggressive investors. In 2014, the largest endowments
were heavily into private equity, venture capital, and junk bonds. And these
assets paid off. The endowments earned more than 15 percent in 2014, on
top of an 11.4 percent return in 2013. All exempt from capital gains taxes. In
2013, former Reuters columnist Felix Salmon memorably called Harvard, “a
hedge fund with an educational institution attached.”
As Fleischer noted, the twin exemption for both contributors and the
endowments themselves at least creates an environment for a troublesome
conflict of interest: Wealthy investment managers make big taxdeductible
gifts to the universities. The endowments hire the giver’s investment firm to
run their money, paying extremely generous fees in the process. Fleisher
doesn’t try to prove a quid pro quo, but it is worth asking why taxpayers
should be subsidizing these incestuous relationships.
Of course, some taxdeductible alumni gifts are used for tuition assistance,
much of it aimed at lowincome or otherwise disadvantaged students. But
not all of it. High endowment schools often enroll low percentages of
students eligible for Pell Grants. And the highest paid employees of many
universities are the internal money managers who run the endowments
(and, of course, the football and men’s basketball coaches who are also
funded at least in part by taxexempt booster money).
Backers of the current taxexempt status will argue, rightly, that removing
the exemption will shrink aftertax returns and leave less money to help
needy students. I suspect that’s why Fleischer would allow them to retain the
exemption as long as they spend at least 8 percent of their endowments
annually. Typically, foundations must spend 5 percent.
In 2008, the thenchair and ranking member of the Senate Finance
Committee, senators Chuck Grassley (RIA) and Max Baucus (DMT) floated
the idea of a 5 percent mandatory payout for universities. It went nowhere.
The Nexus study has an alternative solution: Impose a modest excise tax on
endowments in excess of $500 million. One could also require something
like the community benefit obligations required for nonprofit hospitals. In
such a model, a fixed percentage of endowment funds would be targeted to a
specific, wellidentified need.
But why not just make the endowments taxable and use some of the huge
revenue windfall to boost tuition assistance and other supports for those
students who really need it?
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