Finance

Rich School Endowments Aren’t Taxed. Washington Is Out to Change That

Whatever happens with the proposed levy on private schools’ investment earnings, now it’s out in the open: The Republicans are hungry for college cash.

Princeton.

Photographer: Craig Warga/Bloomberg via Getty Images

A threat that U.S. private colleges and universities have dreaded for years just got closer to reality: Republicans in Congress want to tax rich endowments. The sweeping 400-page tax bill unveiled on Nov. 2 includes a 1.4 percent levy on private schools’ investment income. It’s one of many ways the bill is trying to raise money to partially pay for slashing corporate rates and other cuts. The tax could apply to private institutions with endowments of more than $250,000 per full-time student, according to a later amendment to the bill. That group includes about 70 colleges and universities.

Regardless of the final shape of the tax—or even whether it passes—it’s clear that Washington has its eyes on the pile of money that colleges have amassed. About 800 endowments together hold more than $500 billion, led by Harvard with $37.1 billion. Thanks to a strong market, many schools are richer than ever, and they don’t pay taxes on their investment earnings. Their funds have become major players in the financial markets, with investments in hedge funds, venture capital, and real estate.

This isn’t the first time Congress has looked at endowments. The focus has sometimes been less on taxing schools than on pushing them to use more of their money to help offset ever-rising tuitions. After a U.S. Senate Committee on Finance hearing in 2007, Chuck Grassley, an Iowa Republican, merely mentioned the idea of requiring a 5 percent annual spending rate for colleges. That whiff of a threat seemed to spur changes. Within months, about three dozen colleges said they would spend more on financial aid. Schools including Harvard, the University of Pennsylvania, and Pomona College adopted measures to replace loans with grants, which don’t need to be repaid. Still, the wealth at some schools remains a tempting target for lawmakers. “If we look at major universities, they haven’t done a very good job of explaining why they’ve accumulated this money,” says Henry Hansmann, a Yale Law School professor and economist.

The current proposal would tax large endowments regardless of an institution’s spending rate. It has its roots in a 2014 plan from Dave Camp, the former chairman of the House Ways and Means Committee. Camp, a Republican, says he wanted to put endowments on the same footing as foundations. Depending on how much they spend annually on grants, charitable activities, or other qualifying purposes, foundations pay either 1 percent or 2 percent in tax. Under the new bill, both foundations and endowments would pay 1.4 percent. “When you have similar activities, why should they be treated differently under the tax code?” asks Camp, now a senior policy adviser with PricewaterhouseCoopers LLP’s tax practice.

Colleges say this tax proposal would only leave them with less money to spend. They generally try to spend from the returns from their endowments, and the tax would take a bite out of that. “If we have to send millions of dollars to the federal Treasury, that’s millions of dollars we can’t spend on financial aid, academic programs, or research,” says Robert Durkee, vice president of Princeton, which has an endowment of $23.8 billion—or almost $3 million per student. Durkee says Princeton plans to spend more of its endowment to fund an expansion of the student body and that it provides aid to 60 percent of its undergrads. The endowment funds more than half the school’s operating budget.

Berea College in Kentucky is unusual for having a relatively large endowment while enrolling only low-income students who pay no tuition. Jeff Amburgey, its vice president for finance, says the tax could cost the school about $1.9 million annually and mean enrolling 48 fewer students each year. “It would have a negative impact on what we are trying to do here at Berea,” he says.

Mark Schneider, a vice president at the nonprofit group American Institutes for Research, has proposed that money raised from taxing endowments could be redistributed to community colleges or regional state schools. This bill doesn’t do that, while it does cut taxes paid largely by high earners. Still, Schneider is happy to see the idea on the table. “It’s about time,” he says.

Colleges should be warned that they need to justify their wealth, says Leon Botstein, president of Bard College, which has an endowment of about $61,000 per student. “One could make a long list of how they could spend it in the public interest—giving more scholarships, the quality of instruction, and to help, for example, bridge the connection between high school and college,” he says.

    BOTTOM LINE - The Republican tax proposal seeks to impose a 1.4 percent levy on the investment income of college endowments, some of which are worth tens of billions of dollars.
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