Tag Archives: College endowments

The Case for Taxing College Endowments

Republicans inserted many provisions in their House and Senate tax reform bills that have inflamed the higher education establishment, including a proposed excise tax on endowments exceeding $250,000 per student at private schools. Although only about 70 schools are affected that collectively enroll under 10 percent of the students attending four-year American universities, from some rhetoric of university leaders you would think that the very foundation of American higher education has been dramatically impaired.

Now Universities Have Detractors

There are two good reasons why the endowment tax makes sense to some politicians. First, public attitudes toward universities have distinctly soured in recent years. What the public perceives as outrageous student behavior, feckless university leadership, and excessive tuition fees has combined with a growing hostility by Republican lawmakers angered over the large political donations and public criticism that academics have made attempting to oust them from office. Lawmakers are growing tired of feeding the mouths that bite them. Revenues raised by taxing colleges can modestly help fund other tax reductions that lawmakers want to make, which are probably economically beneficial to the well over 90 percent of the population living outside the Ivory Towers of Academia.

Second, our econometric examination of college endowments suggests a large portion of endowment income is dissipated in relatively unproductive fashions, financing a growing army of relatively well-paid university administrators and giving influential faculty low teaching loads and high salaries. We estimate that roughly only about 15 cents out of each additional dollar of endowment income goes to lower net tuition fees (published tuition fees—sticker prices– are much higher at highly endowed schools, but those schools also give more scholarship aid). When a newly endowed scholarship is created, schools typically either reduce their student aid support from other funds or raise sticker prices to capture some of the newly funded endowment resources for other purposes.

Academic Gated Communities

The late Henry Manne once suggested that so-called “not-for-profit” universities actually are “owned” in reality, if not legally, by powerful faculty and administrators. These schools generate financial surpluses that, while not legally profits, are viewed by powerful university constituencies that consider themselves the true “owners” of the university as the equivalent of profits, a large portion of which are then distributed as “dividends.”

A healthy portion of these dividends are used to provide higher salaries or other perks such as hiring lots of new administrative assistants such as more assistant deans, “sustainability coordinators” or “diversity officers” to perform irksome jobs or meet politically correct objectives such as fighting global warming or achieving the optimal skin colorization of the students and faculty. As endowments rise, so do full professor salaries and the numbers of professors serving a given number of students. To a considerable extent, endowments are a successful rent-seeking scam of the power brokers within universities

At public universities, subsidies are provided by state governments that usually are less than $1,000 a student but are occasionally higher. The five highest state appropriation levels per student among the 13 public Big Ten universities range between $10,000 and $15,000, equal to the amount that would be provided by an endowment of $250,000 per student where the annual spending rate is four to six percent of the endowment principal. Thus, the GOP excise tax on endowments takes effect only at institutions where endowment spending is generally well above the public subsidies provided at state universities.

At Princeton, the endowment per student far exceeds $2 million, providing probably at least $100,000 in university spending per student. Despite these extraordinary resources, the school still has published tuition and fees for next year of $66,510 –and, if the Princeton website is to be believed, 40 percent of students pay the full price. Why should governments subsidize gifts to increase even further the extraordinary amount of spending that goes on at academic gated communities like Princeton?

Moreover, the proposed endowment tax is actually relatively modest. Suppose a school with a $10 billion endowment (about the size of that at Northwestern or Columbia universities) had a pretty good year, making $1 billion from dividends, interest, rents, and unrealized capital gains. As I understand the proposed legislation, it would pay less than $15 million in federal excise taxes.

We usually subsidize universities because they have what economists call “positive externalities” –good spillover effects that benefit all of society. But campus riots and other campus pathologies can lead to negative externalities –bad societal spillover effects. The GOP excise tax proposal reminds me of an email written me in 2002 by Milton Friedman, in which he suggested “a full analysis…might lead you to conclude that higher education should be taxed to offset its negative externalities.”

Alerting Clueless Administrators

An endowment tax would typically raise only a few hundred million dollars annually. Why bother? It likely will not dramatically alter behavior. Still, the proposal has considerable symbolic and informational value. It does send a warning to politically relatively clueless college administrators that their special privileges as institutions should not be taken for granted, and, indeed, are under intense scrutiny.

The call for an endowment tax also receives some modest support from the fact that very large endowments have sometimes eschewed the conventional belief that these investments should be made conservatively, emphasizing publicly traded stocks and bonds. The traditional view is that investments supporting public institutions should emphasize risk minimization more than wealth maximization. Exotic hedge fund investments in the Cayman Islands and the annual payment of tens of millions of dollars to endowment managers strike many as inappropriate for universities or at least something that should not be subsidized through special tax preferences.

An excise tax on large endowments is unlikely to alter collegiate investment behavior dramatically, nor is it going to be a large revenue raiser at the proposed rate. However, neither is it likely to do much harm and it has some positive symbolic value.

Top College Endowments Are Political Targets Now

One of the pillars of our education establishment, The Education Trust, recently published a report meant to pressure colleges and universities with large endowments into spending more of their earnings on one of its pet causes – very low or even free tuition for students from poorer families. The study, “A Glimpse Inside the Coffers: Endowment Spending at Wealthy Colleges and Universities,” claims to show that these institutions “aren’t doing nearly enough” to help such students.

To cite just one example from the report, suppose that the University of Pennsylvania were to raise its endowment spending up to Education Trust’s recommended five percent level – and spent all of the additional money on reducing tuition for poor students. By doing that, Penn could double the number of low-income students entering the school, from 109 per year to 218 per year.

Now, I am no fan of the way our colleges and universities that have gigantic endowments choose to spend their money. I think that too much goes toward the student amenities arms race, toward the hiring of unnecessary administrators who have to pretend to be busy at jobs such as “Vice President for Diversity and Inclusion,” and toward luring “star” faculty members who don’t teach much, away from other schools. But just because they waste a lot of money already is no reason to favor Education Trust’s plan.

Related: Another Bad Idea—Mandatory Endowment Spending

Here is the fatal flaw. Going to an elite, high-cost college is little or no better than going to a lower-cost, non-elite one. Sometimes, in fact, students (no matter their family’s finances) get a superior education at a non-prestige school where there are fewer distractions and where the faculty pays more attention to the undergraduates.

Is Prestige Worth the Cost

Sticking with Penn, let’s suppose that the university decided to follow Education Trust’s advice and succeeded in enrolling an addition 109 students from low-income families with very low tuition and other fees. Penn is indeed a very famous school, but where would those 109 students have gone otherwise?

Perhaps some would have gone to a private liberal arts college in the state or region. Grove City College is a possibility. For decades, the administration at the school has kept costs to the lowest possible level (although certain it isn’t free) and, even more important, students get lots of direct attention from the faculty. Courses are taught by experienced professors, not by grad students. The curriculum remains solid, not full of trendy, narrow, politicized classes.

Yes, a degree from Penn is regarded as prestigious – far more so than a degree from Grove City or most other schools, public or private, in the state. The question, however, is whether that prestige is worth the trade-offs to get it.

Evidently, the people at the Education Trust (along with a majority of America, I’d guess) think so. That is because they have bought into “the Chivas Regal effect” – namely the notion that something must be better in quality simply because it costs more.

Leaders at our high-cost colleges have been promoting that idea (and cashing in on it) for years. It just isn’t true, however. Going to a high-cost, elitist school is neither necessary nor sufficient for students to get a good college education and get on track for a successful career.

I don’t often agree with New York Times writer Frank Bruni, but his book Where You Go Is Not Who You’ll Be nailed an important truth. (My review of the book is available here.) Students often do very well at colleges that almost no one has ever heard of; conversely, the environment of big, famous schools can be damaging to some students.

I will add one further objection to Education Trust’s “More Free College!” idea. To the extent that Penn or any other wealthy university enrolls more students who are from relatively poor families, it will also have to reject an equal number of other students who aren’t from low-income households. Some and probably most of those students will be very highly qualified students who were eager to go to Penn despite the cost.

Those students will most likely be ones who don’t check off any “diversity” box and are therefore expendable in the school’s enrollment management calculus – in other words, sharp Asian kids. They will have to settle for one of their backup schools.

I’m not saying that is a national disaster, but it does mean shuffling some of our best students away from colleges where they’d have been challenged and into ones where they’ll do fine but perhaps not their very best.

For all the lip service they pay to various “social justice” ideas, college leaders, are pretty steadfast in protecting their freedom to use their wealth as they think best. I hope they live up to that and ignore the Education Trust.