At the Witness Table in Congress: University Endowments

The Senate Finance Committee has held hearings and the House Ways and Means Oversight Subcommittee is beginning their hearings into college and university costs and how their endowments are used to offset those costs. The justification for these investigations is that the academic industry enjoys a significant tax break in the form of tax-exempt status and the charitable contribution deduction passed along to donors. Congress has said it wants to understand the public benefit of these tax breaks.

Earlier in the year, I reviewed the questions asked by Congress of the 56 institutions with the largest endowments. Today I assess where Congress seems to be heading with this information.

First let’s take a look at the value of the tax breaks that higher education enjoys. Because these institutions are tax exempt, they do not pay income taxes on the investment returns earned by their endowment funds. A Congressional Research Report estimated that taxing investment income at the 35 percent rate would have produced $16.2 billion in tax collections in 2014. In addition, it was estimated that $6.3 billion in tax savings were realized by the individual and corporate donors. This $22.5 billion is substantially more than the estimated cost of President Obama’s plan for providing free community college to everyone who qualifies. Is this where the free college advocates are looking to pay for their proposals?

Of course, tax-exempt status was written into the Internal Revenue Code because Congress recognized the value of an educated population. Tax-exempt status subsidizes the public good of sending people to college. This has not changed. So what is Congress really after?

House Ways and Means Oversight Subcommittee Chairman Peter Roskam believes that the skyrocketing cost of college is an indicator that endowments are not being used properly—presumably for tuition relief. This appears to me to be mixing apples and oranges. On one hand, it is obvious that Congress needs to understand what is driving the increasing costs at colleges and universities. Increasingly luxurious campus amenities is one cost factor, but is quickly justified by university spokespersons as a competition-driven need to attract students. So getting costs under control is one thing—and it is completely different from the question of how endowment earnings are used.

Why aren’t endowment earnings used to reduce tuition costs? The institutions claim that their hands are tied because by law, they are required to adhere to the donors’ wishes and can’t redirect funds. This is somewhat disingenuous as money is fungible and donations that are restricted to a specific need should free up resources previously directed toward that need for other purposes, including tuition relief. In my mind, all spending that does not come from student tuition that is funded from other sources is already reducing tuition costs. That is, unless there is unnecessary spending taking place.   

Congressman Tom Reed of New York anticipates introducing legislation that would require institutions with endowments greater than $1 billion to devote a fixed portion of their endowment to offsetting student costs. Unless you are willing to postulate that institutions are currently wasting endowment income  on unnecessary expenditures, then institutions must currently be spending 100 percent of their endowment income on expenses that reduce student costs. Doesn't a necessary expense paid by endowment earnings constitute an expense that does not have to be paid by student tuition, thereby offsetting student costs?

One truth that appears to be gaining traction at the hearings is that the richest private schools are getting wealthier while the public two-year and four-year schools see the disparity between them and the private schools widen. One reason for this is that the investment returns at larger endowments are usually greater than the returns achieved by smaller funds. In 2015, endowment funds investing over $1 billion enjoyed returns of 4.3 percent while endowment funds under $50 million experienced returns of only 1.9 percent on average. This reflects a basic investment truth that the greater diversity you have in your portfolio, which is the case for many large endowments, the greater will be your investment returns.

A second reason why the richer schools grow continually richer is that donations to the larger private institutions usually significantly outpace donations to the smaller and public institutions. Is this a reflection of the financial success of their graduates, or are they just doing a better job of fundraising? If Congress does something to redirect these resources to other institutions, will the donors continue to support these institutions to the degree they are now? If the donors reduce their giving, what will have been achieved?

My take on this is that Congress (both parties) are mainly concerned about the growing assets of a small number of affluent elite schools. Just as many in Congress would like to reallocate more wealth among all citizens, some appear keen to reallocate wealth among colleges and universities. Or perhaps this is just a good campaign issue and universities are easy targets of public anger. But this investigation has gone on for a long time, and I am concerned that it is not just going to die out with no action. What's more, I do not believe the actions contemplated are heading in a good direction.