Many of America’s elite colleges sit on massive pots of money, some worth billions of dollars. These endowments have grown significantly in recent years, the result of philanthropy and savvy investment techniques—and all the while they’re completely untaxed.
That’s poised to change, though, if GOP lawmakers succeed in enacting their tax-overhaul bill, which is now inching closer to becoming law: The bill stipulates that certain higher-education institutions would, for the first time ever, have to pay a tax on the income from those assets. The proposal comes at a time when lots of schools are struggling financially—including some that on paper might look like they’re swimming in cash.
As it stands, the provision would levy a 1.4 percent tax on the investment income that wealthy colleges—the 60 or so institutions whose endowments are worth at least $250,000 per full-time student—make on those assets. Experts estimate that the tax would generate between $250 million and $300 million in revenue annually, which could range from as little as a few hundred-thousand dollars from small liberal-arts schools such as DePauw University to $43 million from Harvard, according to university spokespeople. That might not seem like a lot, but college officials indicate it’d significantly detract from their ability to fund operations and student aid. Both the House version of the bill, which passed the chamber earlier this month, and the Senate’s version, which is expected to receive a full vote this week, seek the same tax on endowments. If the legislation passes Congress, it would go into effect almost immediately, requiring colleges and universities to start paying up in 2018.
“This [legislation] ensures that private endowments are placed on equal footing with private foundations,” Republican Representative Kevin Brady, the House bill’s key architect and the author of the endowment-tax amendment, said in a statement earlier this month. Private foundations, by contrast, are required to spend a minimum of 5 percent of their assets each year and are subject to a 2 percent excise tax on investment income.
Endowments—which are funded through donations and are primarily invested in an assortment of financial markets—are used to pay for all kinds expenses including financial aid, research, and facilities. They are in many ways a logical source of new tax revenue. In 2016, the wealthiest colleges spent on average just 4 percent of their endowment income; the rest remained in investment portfolios. This at a time when endowments grew by 13 percent on average.
Endowment-reform advocates describe this dynamic as one of elite higher education’s most egregious hypocrisies: Colleges often argue that economic realities hamper their ability to broaden access for needy students and prevent spiraling tuition costs, but the size and nature of their endowments suggests that they have other options. While certain donations come with spending criteria, there’s no rule that says colleges can only spend a certain percentage of their assets annually.
In 2016, America’s 50 wealthiest universities reported endowment wealth of $331 billion total, worth triple the size of California’s state budget; this represents a vast increase from two decades prior, even though the percentages of low-income students served remained relatively constant over the same time period. According to research based on data from 1999 to 2013, fewer than 4 percent of the student populations at the so-called “Ivy-Plus” institutions (the Ivies along with Stanford, the University of Chicago, MIT, and Duke) came from families in the bottom 20 percent of the income distribution, while 14.5 percent came from the top 1 percent. Additionally, tuition at private colleges and universities skyrocketed during that period, growing from an average of a little more than $24,000 in 1997 (as adjusted for inflation) to nearly $42,000 this year, according to U.S. News & World Report data.
The country’s budget deficits and colleges’ frugal handling of their assets are good cause for a tax on endowment income. Bill proponents have described the legislation as one geared toward holding colleges accountable. “There is a culture of excess, a culture of abuse, and we really need to put a spotlight on it,” Nevada Republican Representative Tom Reed told The Washington Post in early November, noting that he’d support an exemption for schools that dedicate a large percentage of their assets to financial aid. The Ways and Means Committee spokeswoman Lauren Aronson suggested in a statement that the amendment would prevent affluent colleges from hoarding so much of their investment income, requiring that they instead contribute it to tax revenues that can then theoretically benefit current and future students’ livelihood.
Still, observers from across the political spectrum—including trade-organization leaders, education scholars, and conservative columnists—are concerned about Congress members’ intentions because wrong motivations could end up further hurting students. The proposal isn’t grounded in a belief that colleges ought to loosen their grip on their assets, some critics argue, but rather in a mission to increase revenue in support of a giant corporate break. Others have even speculated that the endowment-tax proposal reflects a broader GOP campaign to combat American intellectualism.
Absent the right intentions, the tax could exacerbate the very problems previous endowment-reform efforts have endeavored to eliminate. “What [Congress has] ended up with is not a solution to a public-policy question” about equity and access, said Terry Hartle, who oversees government and public affairs for the American Council on Education. If Congress was indeed intent on advancing a public-policy solution, he suggested, it’d explicitly direct the revenue from this tax to, for example, financial aid. Mark Schneider, the vice president of the American Institutes for Research and an advocate for endowment taxes and regulation, offered a similar take on the bill’s failure to specify how the endowment-tax income would be spent. “Getting the principle [of greater endowment accountability] on the books is good,” he said. But if Schneider were to have his way, revenue from the endowment tax would be earmarked for community colleges.
One interpretation of the provision’s lack of specificity is that the GOP has other goals. “I think it’s an effort to take away a bit of power” from prestigious colleges and universities, said Marybeth Gasman, a University of Pennsylvania education professor whose expertise includes fundraising and philanthropy. “There’s this anti-intellectualism in the GOP. They feel that a lot of the universities are bastions of liberalism.” The bill does indeed propose lots of new taxes that threaten to undermine the financial health of colleges and the students and faculty they serve. Some estimates indicate that the legislation—which would also eliminate the student-loan interest deduction and treat graduate-student tuition waivers as taxable income—would reduce benefits for higher education by more than $60 billion in the coming decade.
It’s a contingency about which university leaders are growing increasingly nervous: Never before has the enactment of an endowment-reform proposal seemed so likely. I met, for example, with Harvard President Drew Faust for lunch the other week just hours after she’d testified against the tax bill before Congress and asked about her outlook on the legislation. Her consternation was palpable.
The estimated $43 million that Harvard would have to pay in taxes annually might seem like pennies compared to its $37 billion endowment, but Faust says the financial burden would severely detract from its ability to support students and faculty through expenditures ranging from financial aid to medical research. “Harvard’s endowment is not locked away in some chest,” she said in a statement earlier this month, noting that endowment proceeds fund nearly 40 percent of the university’s operations. “It is at work in the world.”
The vast majority of endowment wealth is invested in a series of distinct funds, many of them subject to spending criteria stipulated by the given donor; this wealth-management strategy serves as a means of ensuring long-term financial health for future students and faculty. That’s why colleges typically spend only about 5 percent or less of their assets annually, according to Tracy Filosa, an enterprise advisor at Cambridge Associates—not because the institutions are stingy but because they’ve identified that spending rate as a sweet spot that allows them to retain both a good cash flow and long-term security. If the endowment tax is enacted, many institutions will decide to draw what they owe to the feds from the pot of money that would otherwise be spent. It’s either that, or continue spending 5 percent and “erode the endowment that’s available in the future,” said Filosa, who works with universities to align their endowment portfolios with their institutional mission.
For some, most nerve-wracking is that the endowment provision could serve as harbinger for a larger push to tax the endowment incomes of less-wealthy, and even public, institutions, too. “I talk to college and university presidents every day, and I’ve had more conversations about this than about any other issue,” said Hartle of the American Council on Education. “You’re on this list [of 70 or so colleges], you’re worried about it. But even schools that are not on this list are worried because they see it as a precedent.”