Sunday, May 13, 2007

The Tax Status of University Contributions and Endowments

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.


Bob Yates said...

Our gracious host teaches at a public university and yet he writes:

I don't like taxes, and think they are inimical to growth.


I wonder if he thinks our military should be holding bake sales to finance the war in Iraq.

I wonder if he thinks it would be better to give his local police and fire department a credit card before they come to his house.

This means of communication was made possible because of taxes. Of course, the government investment in ARPENET created an entirely new industrial sector. It was this entirely new sector that fueled the growth of the US economy in the 1990s.

TC said...

I'd rather have my taxes spent on a professor who teaches the effect of taxes on economic growth than a Ward Churchill who teaches conspiracy theories on my dime.

If you think the government knows: how to invest in research better than the private sector, spend your money more effectively than you, and decide what is best for you, you have the opportunity to vote for tax and spend democrats - and by the way, the republicans did a damn poor job on fiscal responsility in the last congress.

I don't see anything wrong with "our gracious host" making such a comment. It's no worse than an employee of a company criticizing that company if they believe the company is poorly managed.

Receiving money from the fed's does not preclude one from annunciating their opinion on a blog that is not under governance by a college, university, or the feds.

There is enough waste, pork-barrel spending, inefficiency, and outright embezzlement - as demonstrated with the student loan scandle, in our government to fund gargantuan programs without raising taxes one cent. Personally, I hate paying taxes.

When you say "ARPENET", I suspect you are referring to ARPANET developed by ARPA of the United States Department of Defense. And I agree with you that this program, started in the latter half of the 60's has created a new industry - but I disagree that it single handedly has fueled economic growth in the US. In fact, in the context of the internet, it turned into bubble that eventually popped.