What's Really Driving Government Pressure on University Endowments?

Although we are in the middle of our analysis of Congress’ investigation into the endowment funds of colleges and universities, recent news articles may point to the real agenda behind this investigation: Government has a big appetite for money and is drawn to anyplace where it exists in moderate to large quantities.

Frequently, a charge imposed by a government is masked as a cost associated with a public benefit. For example, before a person receives a license to drive a motor vehicle, they are tested by the government and pay a fee. Government tells us this testing and licensing keeps unsafe drivers off of the roads. Why, then, are only drivers getting their initial drivers’ license (usually around age 16) subject to testing while the rest of us pay annual license fees until the age of 90 before the government might want to test us again? From age 16 onward, annual license fees are merely an income opportunity for government.

So it was not unexpected when the Connecticut legislature introduced legislation this March that would impose a tax on schools with endowment funds in excess of $10 billion. In Connecticut, this would affect only Yale University, the 300-year-old institution whose $25.6 billion endowment is the second largest in the U.S. The Connecticut legislature probably sensed some opportunity and urgency, given the scrutiny that large endowment funds are now receiving from federal lawmakers, and wanted to stake its claim before the federal government could impose a tax of its own. Of course, the $266 million budget deficit in Connecticut is unrelated to this action.

The Connecticut Legislature is trying to frame this discussion in parallel to Congress’ recent letter to 56 colleges and universities asking why endowment balances are growing at the same time that tuition costs are increasing faster than the rate of inflation. The legislature claims that Senate Bill 413 allows universities (actually only Yale) to improve affordable access to higher education and create innovative, high paying jobs. Affordable access is a direct parallel to the letter from Congress and fits nicely with the recent discussions about endowment and donor-advised fund spending rates.

The Connecticut legislature claims that S.B. 413 does not contain a spending requirement and does not threaten the tax-exempt status of the endowment. They claim that the bill actually includes a spending incentive. How? According to Senate President Martin M. Looney, the bill extends tax-free treatment to all of the endowment’s growth that is re-invested in higher education or in the broader Connecticut economy.  

What does that mean? The university would complete a form that would take endowment earnings and subtract qualified expenditures made in higher education or the CT economy. If there is an excess of earnings after this calculation, that amount would be subject to tax. Looney calls this tax something like the Unrelated Business Income Tax (UBIT) that tax-exempt charities already pay on non-charitable activities. Make no mistake, this is not UBITit is an entirely new tax on excess earningsor earnings that are not spent on deductible items. Is this a spending incentive? I suppose to the extent that people and institutions spend money on tax-deductible items just to save taxes, then this law is a spending incentive.

What is hidden in this proposal is the eventual, and almost certain, superabundance of regulations that will define and refine what is a qualified (read: “deductible”) expenditure for investments in higher education or in the broader Connecticut economy. This is the beginning of a new tax code that will define income and deductions, the result of which will be subject to a tax. All of you who believe the Internal Revenue Code is a spending incentive will gladly support this tax-based incentive for Yale University.

Continuing this populist language, the head of the Connecticut senate indicated that it was their hope that “these rich schools” would use their wealth to create job opportunities “rather than simply to get richer.”  Yale already makes a voluntary $8.2 million payment to New Haven as a Payment in Lieu of Taxes. I question how voluntary such payments actually are, since governments have created a specific name for themPILOT programs.

It is not like institutions such as Yale are not already a positive influence on the community in which they are located. The foundational concept that underlies all of the tax exemptions afforded to not-for-profit organizations is in recognition of the benefits of having such institutions in your own back yard. Governor Rick Scott of Florida understands this perfectly, as he very seriously extended an invitation to Yale to relocate to Florida along with a guarantee that they would never be taxed.

In testimony on Senate Bill 413, Richard Jacob, the associate vice president for government relations at Yale spoke eloquently about Yale’s commitment to the community. Most obvious is the $2 billion in taxable wages and benefits that the university spends in New Haven. Yale is the largest employer in New Haven and the fifth largest employer in all of Connecticut. In addition, students and visitors to Yale spend around $150 million in the community annually and it is estimated that Yale’s total impact on the Connecticut economy was around $8.8 billion. Would Governor Rick Scott like to have this tax-exempt economic engine running in Florida? You bet he would, as would the governors of many other states.

Unfortunately, Yale has been in New Haven for over 300 years and is committed to its history and the area. But recently, GE decided to move its world headquarters from Connecticut to Boston, Massachussetts and indicated that the unstable tax climate in Connecticut was one of the prime reasons. Not every not-for-profit may be as committed to its current location as Yale University.

The lesson here for charities is to recognize that as you strive for fiscal stability, you become a target and risk being viewed as an income opportunity. Jacob presented a dazzling array of facts and figures in his testimony. Every not-for-profit should be ready and able to present such a solid defense of their tax-exempt statusa privilege that was initially extended to charitable organizations because local communities recognized how valuable they were. Don’t let your fiscal stability and appearance of wealth detract from that reality.