Do Elite Universities
Abuse their Tax Subsidies?
A recent
op-ed in the New York Times with the provocative title “Stop Universities
from Hoarding Money” once
again raises the issue of university endowments. It focuses in large part
on the extraordinary amounts elite universities either “hoard” or spend on fees
to investment advisors and hedge funds in contrast to the much smaller sums
spent on “tuition assistance, fellowships and prizes,” those things seen as the
university’s true mission. The author,
a tax professor, suggests that universities with endowments in excess of $100
million should be required to expend at least eight percent of their endowments
each year. This is not a new proposal; similar
proposals arise periodically. Of course entities with such large sums
(Harvard’s endowment is reported
to exceed $32.5 billion) are formidable players in politics so these calls
generally go unheeded.
To understand why we all have an interest in these matters one
must know a thing or two about federal tax law as it applies to charitable
organizations. Universities are classified as “public charities” which status means
that they can generally earn and accumulate money exempt from federal income
tax. Policy experts sometimes refer to these benefits as a taxpayer “subsidy,”
to the university, because exempting the university from tax is the same as
taxing it like other entities and then returning to it its tax payments rather
than using them for other public benefit. Imagine the potential tax liability of
an institution like Harvard if its receipts (tuition, income and gains on
investments) were subject to the income tax. That figure would reach at least
tens of millions of dollars annually. The idea behind the tax exemption, of
course, is that it allows universities to provide more research, knowledge and
education—all seen as public goods. And tax-exemption is not the only federal
tax subsidy from which universities benefit. Donors’ taxes are reduced when
they make contributions to universities through generous tax deductions. Like
exempting universities from the income tax, subsidizing donations to those
institutions with taxpayer dollars increases the availability of the public
goods produced by universities.
By implementing the foregoing tax benefits, Congress apparently
assumed that we (the taxpayers) are getting what we pay for. But is that true
as respects university endowments? Why does Harvard have $32.5 billion and what
is it doing with all that money? Why did Yale pay $480
million to private equity fund managers compared with $170 million for tuition
assistance, fellowships and prizes? Should these wealthy elite universities
be spending more of their endowments on their core mission? That question has
been considered by a couple of scholars. Unfortunately, the results seem to
suggest that when it comes to at least some university endowments, we are not,
in fact, getting what we pay for.
It seems to be generally accepted that a university should
spend no more of its endowment than the endowment generates in income and
(perhaps) capital appreciation. Many spend income only and allow capital
appreciation to accrue, which will generally allow an endowment to grow much
larger over time. These practices are justified on the basis of
“intergenerational equity.” Maintaining the endowment’s value over time means
that it can continue to support the university’s activities indefinitely. But a
1990 study
found that the basis for the intergenerational equity argument had little merit.
And the fact remains that elite university endowments are growing at
substantial rates.
A more recent
study, undertaken in 2010 sought to determine why universities, in the immediate
aftermath of the 2008 financial crisis, slashed operating budgets, laid off
employees, froze salaries, and delayed expansion projects, among other things,
rather than dipping into multibillion dollar endowments. Reasons given by the
universities were that pre-crisis spending was unsustainable, the endowments
were legally restricted as to use, and that the investments were generally
illiquid and difficult to access. This study found each of these reasons to be
unpersuasive. The author concluded that the endowments served primarily as
status symbols, and that universities would reach for any other source of
funding to avoid diminishing their endowments.
There is certainly precedent for requiring tax-exempt
organizations to expend a minimum percentage of their assets. Private
foundations are different from public charities in that rather than being
supported by a wide range of public contributions they might be funded only by
one family or even one individual. Because private foundations are not
“publicly-supported” federal tax statutes require them to expend at least five
percent of their net investment assets on charitable endeavors each year.
Failure to comply subjects them to a potentially crippling penalty
tax. Under the same principle, universities should be using their tax-subsidized
endowments to support their core charitable missions. Those who don’t should be
penalized.
Kent D. Schenkel
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