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“Each student room has triple-glazed mahogany casement windows made of leaded glass. The dining hall boasts a 35-foot ceiling gabled in oak and a ‘state of the art servery,’” BusinessWeek’s Anthony Bianco reported in a recent story.
There’s nothing wrong per se with Princeton University building such plush dorms for its students. But Princeton should pay for them itself out of the college’s $16 billion endowment rather than asking taxpayers for subsidies.
Colleges receive lavish subsidies from the federal government in the form of not-for-profit tax treatment, financial aid for students, and research grants. Such subsidies free up funds that schools often use to enlarge their endowments.
Senator Charles Grassley (R-Iowa) wants to revoke the tax-exempt status of rich colleges that don’t spend at least 5% of their endowment each year. Grassley’s proposal should be enacted, because an organization has no right to ask for taxpayer funds if it refuses to spend a significant proportion of its own wealth on its supposed core purpose.
Protected by a large endowment, a college needn’t cut waste or worry about how to employ superior teaching technologies speedily. If compelled to draw down their endowments, colleges would become more insecure about their future and hence motivated to improve their performance.
Wealthy universities, such as Harvard with its $35 billion endowment, are part hedge funds, part universities. Tax policy should reflect this. Rich colleges should have to prove they’re not hedge funds in disguise by spending most of their investment profits on research and education. Or perhaps, as some Massachusetts legislators desire, all colleges with $1 billion-plus endowments should pay taxes. If not—and colleges can continue to accumulate vast endowments without negative tax consequences—expect some hedge fund to get tax exemption by starting a university and redesignating its investors as faculty and students.
The nation’s college and university endowments certainly make tempting targets. To politicians looking to close a budget shortfall without cutting services or score a few points with voters angry over skyrocketing tuition, the richest endowments look like potential solutions. But the two proposals put forth to date—requiring schools to spend 5% of their assets each year to make college more affordable and taxing endowment assets greater than $1 billion—are misguided.
The nation’s 785 educational endowments have assets that exceed $411 billion, and the biggest, like Harvard’s $34.6 billion, get the headlines. But the vast majority are quite small—more than 400 have assets totaling less than $100 million. Any spend-down rule could have a disproportionate impact on the smallest endowments, which typically have the lowest investment returns.
Unlike foundations, which are designed to raise and spend all their funds for charitable purposes, endowments are meant to serve the financial needs of their institutions in perpetuity. They do that by investing their funds wisely, spending a small portion of their assets each year, and squirreling away the rest for the future. Requiring them to spend more than necessary diminishes the endowment’s size and ability to meet future needs of the institution.
What’s more, most endowments consist of thousands of smaller endowments, each one earmarked for a different purpose. An inflexible spend-down rule of 5% would end up a potential logistical nightmare for endowments to manage.
The tax on endowment assets proposed in Massachusetts is equally problematic. If 2.5% of assets of more than $1 billion go to Uncle Sam, philanthropists might find themselves tempted to shop around for a cause that makes better use of their money.
Many colleges and universities already make payments in lieu of taxes to their host communities to defray the cost of municipal services. A tax on endowment assets might be viewed as a form of double taxation.Opinions and conclusions expressed in the BusinessWeek.com Debate Room do not necessarily reflect the views of BusinessWeek, BusinessWeek.com, or The McGraw-Hill Companies.
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