Wealthy Colleges: Ante Up

Colleges and universities should be required to spend 5% of their endowments every year or risk losing their tax-exempt status. Pro or con?

Pro: Put Giving on the Syllabus

“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.

Con: Schools Need Their Nest Eggs

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.

Reader Comments

I agree w/ pro

The cost of a four-year college education is simply piracy.

Misguided

So Mr. Lavelle thinks these ideas are misguided? Maybe what is misguided is the notion that the Harvard endowment/mutual fund be tax free at all. All of these ideas would essentially exclude the smaller endowments from any tax problems (only a small fraction are greater than $1 billion or spend less then the required 5% annually). Better yet, why not set up the endowments as totally separate taxable entities (as they really are) and then any earnings from the endowment used for education/charitable purposes become a tax deduction--just as so with any other massive fund. Any endowment could avoid taxes altogether by using earnings for the intended purpose--and not accumulating wealth for the sake of accumulating wealth.

PNW Trojan

Huge endowments, corporate money, government money, special interest money, continuous huckstering for dollars on more levels than anyone can imagine, plus they sell your kids to marketers like fresh meat to wolves. That is your university today, with mega millionaire presidents and coaches. Just remember back a few years; both the United Way and the American Red Cross were pilloried for being operated like personal, private fiefdoms by socially prominent (but self-serving) individuals. I wouldn't deem to call them leaders, or people. Tragically, one cannot trust anyone or anything in modern America.

Richard Whipple

Con. That the endowments were built with contributions already subjected to taxation appears to have been missed. Setting an arbitrary spending percentage seems ridiculous. I suggest that anyone who advocates such a policy be similarly required to spend at least 5% of their retirement savings every year prior to retirement in order to avoid a significant penalty tax on their retirement savings in their entirety. What's good for the other guy or corporation should be similarly applicable to individuals.

Many colleges, Harvard included, use at least a portion, some a significant portion, of their endowment's earnings in order to defray the cost of tuition through providing fellowships and grants. Decrease the endowment's capacity to earn and you will increase, not decrease, tuitions, or at least the amount of tuition actually paid by the students, which is what matters.

Education Corporation

This is a joke. These schools are no different from any other business out there. They have to worry about how much they bring in and how much they pay out. The fact is that just as in a business you might run, profit is what keeps you alive and well. These schools not only profit but also have set a monetary standard on tuition, so that when our kid turns 19, we expect to pay 40-50-60 thousand dollars per year. They are manipulating our minds so that we believe our kids get the very best. The fact is that your kid would get the same thing for less if the business greed would be recognized by parents and not tolerated. These colleges like Princeton are no different from Goldman Sachs or Credit Suisse. I think as parents and consumers, we must recognize that the college craze is nothing more than what Barbies are to 5-year-old girls. A trend that is inflated to fill the ego of the consumer.

Paul C. Hanna

Endowments are "seed money." They are for pursuing the most promising ideas a school can come up with, and they represent our future.

Under no conditions should the earnings from this "seed money" be spent on regular operating expenses as is the current practice.

All earnings from the endowment funds should be indexed for inflation so as to give a more realistic picture of just how much money is available to fund those projects that are worthy candidates.

DrTaxSacto

The pro side is a con--a con game that attempts to misrepresent the position of the nonprofit colleges and universities. For example, indeed, Princeton does have dorm rooms that have leaded glass--were they built last year?

Ultimately, the benefits and costs of nonprofit colleges must be assessed with some care, which Miller seems unwilling or unable to do. There are differences among college and university endowments but, as Hanna says, endowments are seed money. People like Miller and Grassley want to eat the seed corn.

Miller's entire argument is based on nonsense. Do nonprofits receive "lavish" subsidies from the federal government? Does the research money that is competed for by nonprofits actually provide benefits to government and society or is it just for support?

Are nonprofits better at graduating all types of students? (According to national data, yes.) Is at least a part of the endowment funds used to assist students directly through student aid and indirectly through enhancing the educational program? (Another easy one, yes.) Will the federal or state government manage the money better than the nonprofit universities? If they manage to begin to break down the exempt status of these societal resources (the easiest answer of all--no).

John in GA

Pro. The massive but unexpended endowments that many of the wealthiest schools have amassed, to no apparent good use, should be used in some way, shape, or form.

Yale and Harvard seem to be solely interested in pursuing a mindless increase in their endowments rather than the betterment of society.

Joe

These endowments are already significantly subsidized by taxpayers through the charitable deduction--the rest of us subsidize these gifts, because we think they are going to be used for charitable uses, right? So why not require universities with billion-dollar endowments to spend a reasonable amount on charitable/educational activities? Is that so radical? Obviously, smaller schools would be exempted and larger schools would be able to set aside savings for long-term projects (just as so with the tax rules governing private foundations).

p.j. moran

It helps to have some facts about endowments and the amount that can be distributed to keep up with inflation. A study by Goldman Sachs revealed that an endowment that distributes 5% per year has only a 38% chance of keeping up with inflation 25 year later. It gets worse at 40 years. The effort by Congress to control everything as a means of fundraising, opening up business and other opportunities to themselves, their family members, and their favored contributors is evident in this current drive. If people feel the endowment of a particular institution is too large, they are completely free not to give a dime to it and urge others not to. The thieves in Washington should not be allowed into these endowments to loot them. Once in the door, Congress, which cannot run its own cafeteria, has never failed to loot, abuse, and entrench itself. It won't take long for Congress to get "friends'" children admitted to these school--oh, I forgot, the Ivies and many state universities already do that. This is truly one of the most ill-informed and stunningly stupid proposals to come out of D.C.

Stuart Wilbur

Pro. I am a Baby Boomer college graduate who has been lucky to have parents, wife, and children employed in Edubusiness. I have watched "higher education," formerly a background player in the maintenance of the American caste/class system, rise to become a gigantic engine of self-perpetuating marketing "genius." Because society has acceeded to higher education, the means and voice to determine that everyone who participates in/graduates from college deserves more respect, power, and money than non-graduates, colleges are encouraged to produce even more wealth, power, and prestige for themselves. In the case of most large colleges/systems, I suspect actual knowledge/learning is an accidental byproduct of the edu-industrial process.

Donald Steier

Both pros and cons have their points. But the endowment should be there to help support the school through interest and dividend income. The byproduct, interest/dividends earned should help pay for the college professors' salaries, pay increases, maintenance of the grounds and buildings, and upgrades in books, tools, and equipment used to educate the students. Some endowments are in the millions while others are in the billions. If the schools cannot afford to pay the above-mentioned expenses out of interest/dividends earned from a multimillion and billion-dollar funds, then what are they spending the money on? It certainly isn't being used for full scholarships for students who need and deserve them or to reduce the tuition for all of the students attending the school. Maybe a loss of nonprofit status for some schools might make the others use their endowments for their students and not just the next cocktail party or other social event.

Steve

Accumulating multibillion-dollar endowments shows how successful these institutions can be. If they made their primary focus education and research, imagine how the country could achieve similar success. Economy, energy, cancer, and poverty problems could all become historical footnotes if our we had more of the best and brightest aligned on these tasks.

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