By Richard Vedder
My sidekick Bryan O'Keefe and I met with staffers of the Senate Finance Committee the other day. The most interesting thing about the meeting is that key staffers were there from both the Democratic and Republican side. We talked about many things, but one of them was endowments.
Lynne Munson, a former high level government official, has been chatting with me about endowments, and I think she is on to something. Colleges are typically very secretive about spending from endowments. While they provide information on the aggregate size of the endowments, many don't want you to know what percent of the endowment is spent. Since the corpus of the endowment arose in part because of favorable tax treatment, and because income from the endowment is not taxed, it is possible that a college endowment of, say $1 billion, brings in $50 million annually in dividends and capital gains income, but only spends $20 million of that endowment. Huge sums of money are being tax sheltered, but relatively little is going to financially support the cause for which tax-free funds were provided.
To deal with this problem, many years ago the Feds imposed a 5 percent rule on foundations – that they had to spend five percent of their endowment annually if they wished to avoid taxes. For some reason, universities were excluded from this requirement. Why? Why are universities treated differently than other charitable organizations? Using the 5 percent rule, endowment income per student at some schools is now over $75,000 a year. Are they spending that much? If not, why are we allowing universities to augment their huge endowments TAX FREE by new donations? If they are spending that much, why are they charging tuition at all, given the fact that they raise huge additional research funds and annual private charitable contributions for current expenses. In other words, the Harvard-Yale-Princeton type school has over $100,000 annually per student coming in independent of massive funds for research activity. Since high quality liberal arts colleges typically spend less than that amount per student, why is tuition charged at all? Or is all this tax-exempt money funding amenities at these schools of a non-educational nature, or lining the pockets of the staff via very high levels of compensation?
I don't like taxes, and think they are inimical to growth. But I don't like giving some people special tax status relative to others, particularly when the tax privileges are of dubious social value. Cutting tax exemptions to some of the uber rich schools and giving lower tax rates to all would probably be growth-enhancing. In any case, we need to learn more about how endowment incomes are used.