Moves to make rich schools spend more of their megabucks are gaining traction, and tax authorities spy a new source of revenue
As targets go, this one is a doozy. With assets totaling $411 billion, the nation's college and university endowments are larger than the annual gross domestic product of Belgium. That's enough money to run the federal government for nearly 50 days. Harvard alone has $35 billion. They pay their managers like rock stars, and, as a group, they've been growing at a double-digit rate by making riskier investments. Their ostensible purpose, providing for the financial needs of their institutions, gets a sliver of the total each year, about 4.6% of assets. And they're tax-exempt to boot.
But maybe not for long. Congress, the IRS, and some states are all taking aim at endowments. Senators Max Baucus (D-Mont.) and Charles Grassley (R-Iowa), the chairman and ranking Republican, respectively, on the powerful Senate Finance Committee, have been pushing to force endowments to disperse at least 5% of their assets each year—as other tax-exempt organizations are required to do. A top IRS commissioner, in a speech last month in Washington, said the agency should be "more aggressive" about ensuring that endowments make "appropriate use" of their resources. And lawmakers in Massachusetts are considering a 2.5% tax on endowment assets exceeding $1 billion. It would cost the state's nine mega-endowments—including Harvard, Massachusetts Institute of Technology, and Boston College—an estimated $1.4 billion.
"When you're facing a $1.3 billion deficit, you look for some kind of revenue stream that would be available," says state Representative Paul Kujawski, who brought up the idea during budget deliberations in April. And it's a politically tempting target. The issue, Kujawski said, has "a lot of legs".
Soak the Well-Endowed
Each of the proposals has a long way to go, but powerful economic and political forces are propelling them forward. Resentment against ultra-wealthy schools (BusinessWeek.com, 11/29/07), where escalating tuition is out of reach of many, is running at a fever pitch. And a state tax on endowments has enormous appeal for the 28 states facing budget shortfalls totaling more than $40 billion for 2009—especially the 22 that are home to billion-plus endowments. A New Jersey legislator has already expressed an interest in the Massachusetts proposal, with an eye on Princeton's $15.8 billion nest egg. New York State has seven $1 billion-plus institutions, California has five, and Ohio and Illinois each has three, for assets totaling more than $21 billion.
Unsurprisingly, the educational community opposes all the proposals to tap into endowments, but it has been unable to stop, or even slow, their progress. Indeed, in the past year, Stanford and Yale both voluntarily increased the annual payout from their endowments, and more than a dozen top schools, including seven of the eight Ivy League institutions, overhauled their financial-aid policies to make themselves more affordable for the middle class (BusinessWeek.com, 2/3/08).
But the saber-rattling continues, especially in the light of several years of outsize returns for endowments (BusinessWeek.com, 10/22/07). For the three years ended June 30, 2007, schools with more than $1 billion endowments earned a 16.4% return on their investments, compared with 11.7% for the S—P 500 during the same period, according to the National Association of College — University Business Officers. "The effort to co-opt this whole thing wasn't successful," says Patrick M. Callan, president of the National Center for Public Policy — Higher Education. "I don't see this going away."
Are You a Charity or a Business?
If anything, the critics are turning up the heat. The IRS alone has upped the disclosure requirements for endowments and plans to survey more than 400 colleges and universities in coming months to find out how they invest and use their endowments. Over the next 18 months it will develop a broad new initiative on standards for determining when endowments are spending enough. "If you are sitting on large sums of money and not doing anything with it the question is: Are you doing charitable work?" says Steven T. Miller, IRS commissioner for tax-exempt and government entities, the official who gave the speech calling for more aggressive action on endowments. "The question is what we would do about that, and we're not there yet."
For consumers—that is, students and their families —the stakes are huge. The Congressional Research Service estimates that increasing the annual payout on big endowments, for example from 4.5% to 5%, would allow the 30 schools with big endowments it examined to eliminate tuition increases and double undergraduate financial aid.
But the big-endowment schools make compelling arguments for why a spending requirement creates problems. Most endowments are composed of thousands of individual funds, each designated for a specific purpose. Three-fourths of the Harvard endowment, made up of 11,000 funds, is spoken for in this way. So the 5% spending rule could pose a logistical nightmare. And a 2.5% endowment tax might make a school less attractive to big donors, who want all their money—not 97.5% of it—to serve a philanthropic purpose. Says Kevin Casey, Harvard's associate vice-president for government and public affairs: "They might take that money elsewhere."
Schools also point out that they don't exactly thumb their noses as the taxman right now. Harvard, for instance, pays $13 million in taxes to various jurisdictions for commercial entities on campus that don't enjoy the endowment's tax-exempt status, and $5 million in lieu of taxes to local host communities to defray the cost of municipal services. But for critics of rich endowments, that's not nearly enough.