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If Colleges Won't Use Their Endowments To Pay For Education, It's Time To Tax Them

Around the country, states are thinking about using the tax code to force colleges to address spiraling higher education costs instead of operating tax-free hedge funds.

If Colleges Won't Use Their Endowments To Pay For Education, It's Time To Tax Them

Photo: f11photo Shutterstock

The long-running joke about Harvard—and other universities with hefty endowments—is that they have become hedge funds with universities attached. As of last June, the value of Harvard's endowment was $37.6 billion. Yale had $25.6 billion; Princeton had $22.7 billion. In total, more than $500 billion sits in college endowments. Yale spends more on fund managers than on students.

Unlike hedge funds, however, most universities are nonprofits, and they don't have to pay taxes as their investments grow. And while the richest schools get richer—Harvard's endowment grew more than a billion dollars last year—tuition and student fees keep going up. Because they're not using this extra money to complete their mission of educating students, some politicians are considering forcing schools to start paying out more of their piles of cash in taxes instead.

"Being 1 of 12 kids who was raised by a single mom and having more than $110,000 in student loan debt when I graduated from law school, I understand just how heavy the burden of student loan debt can be for students and their families," says Tom Reed, a congressman from New York who is floating the idea of a new bill to tax endowments. "It is a disservice to the next generation of Americans to continue to allow them to struggle, when we could so easily address the problem of out-of-control costs by making simple changes to our tax code."

Flickr user Stijn Debrouwere

Reed's draft bill would make schools with endowments more than $1 billion spend 25% of their endowment income on financial aid, or they would be taxed. Because donations are often earmarked for specific purposes, making it hard for schools to redirect funds elsewhere, the bill would also make future donors allot 25% of their gifts to financial aid, or they wouldn't get a tax deduction themselves.

A group of tax writers in Congress asked the 52 richest colleges to send details about their endowments by April 1, and they're now poring through the letters that they received. Depending on their analysis, Reed's bill or other legislation may move forward.

The letters, such as this one from Harvard, argue that schools are already spending as much they can. Some schools, including all of the Ivies, provide free tuition to anyone whose family makes less than $75,000, and many (like Stanford, for example) provide a free ride to those who "only" make $125,000. Around a third of Harvard's total annual budget is paid from its endowment. But many schools still have millions, and in some years billions, of extra dollars in endowment income that isn't spent.

"Schools have amassed tons of wealth in ways that are really disproportionate to needs, and frankly disproportionate to the imperatives of 'intergenerational equity,' which is often the excuse that schools use for not spending their endowment," says Joshua Humphreys, resident and senior fellow at Croatan Institute, who has studied the benefits that colleges and universities receive from their tax-exempt status.

Universities are also typically exempt from property taxes—and they own a lot of property—so everyone living in the cities around them ends up paying more for their share of government services like roads. It's more money, often, than local governments realize they're missing. "We were surprised to see that state government and city government don't do a very good job of quantifying the benefits that nonprofits receive, even though those are effectively budgetary line items," says Humphreys, who previously calculated how much Northeastern University was receiving in exemptions. "Those are real expenses."

EQRoy via Shutterstock

Yale owns property worth as least $2.5 billion. Yale does make voluntary payments ("payments in lieu of taxes") to the city of New Haven, but it's a fraction of what it would otherwise owe. Connecticut is now considering a bill that would take away the tax-free exemption for properties that earn more than $6,000 a year.

In total, the exemptions that rich universities receive from federal, state, and local government can add up to far more than other schools get in aid. One report estimated that a student at Princeton, for example, gets a subsidy of about $100,000 a year because of tax exemptions; nearby, a student at Rutgers gets a little more than $12,000. Someone attending a New Jersey community college might get government support of around $2,000. While funding is cut for many state schools, schools that arguably don't need the help get massive subsidies.

That report suggested another use for taxes on endowment income: The government could use the funds to help students struggling at other schools. Last December, the Congressional Research Service said that if returns from endowments were taxed at 35%, the revenue for the 2014 fiscal year would have been more than $16 billion.

In Connecticut, the government considered a third approach—forcing colleges with endowments more than $1 billion (i.e., just Yale) to spend investment returns, or be taxed, but the bill died after the governor said he would veto it.

This isn't the first time that lawmakers have considered taxing endowment income (or forcing schools to spend more of that money on students). Starting in 2008, the Senate Finance Committee also asked rich colleges to share details on their endowments. Congress never passed a law, but the increased pressure and attention did seem to have an effect: Several schools, such as Stanford, suddenly decided to offer free tuition to lower-income students.

Others moved more investments into offshore tax havens. "They're scared that they may have to pay tax at some point in the future," says Humphreys.

It's possible that Congress may act this time, though Reed's bill struggled to gain momentum when he first started pushing for it in January. Meanwhile, college endowments keep growing. The richest schools also keep getting gifts: Stanford raised a record $1.63 billion in 2015. And schools continue to spend only a portion of what they could.

"In my view, it's a wealth-hoarding mechanism at a time when college affordability has been compromised deeply, and we have a massive student debt crisis," Humphreys says.

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