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Tax on College Endowment is Counterproductive

Most people are unaware that the tax reform act includes a college endowment tax that threatens the long-standing tax-free earnings from these donations. Some colleges are in panic mode, especially Harvard, Yale and Stanford. The investment-per-student-threshold was set at $500,000. The tax will raise $1.8 billion over a decade, according to the Joint Committee on Taxation.

Apparently, it’s not clear from the bill how the tax will be calculated, which doesn’t speak well for Congress. Of course, why should we expect our lawmakers to have thought out the details before including this provision. It was Nancy Pelosi who famously said about Obamacare: “We have to pass the bill so that you can find out what is in it – away from the fog of controversy.” Talk about fog, we need to wait on the IRS and the Treasury Department for the rules on taxability.

The NY Times reported on January 19 that the tax seems to disproportionately harm the small colleges with a large endowment. That is because the total endowment is divided by the number of students to get a per-student-average. If it is more than the $500,000 threshold, then the tax kicks in. Logic dictates the smallest schools will have the largest per-student-amount, assuming they have a large endowment. One such institution is Claremont McKenna College, a great school that I had the privilege of teaching at. It concerns me that the tax will hit Claremont McKenna hard because of its relatively large endowment of $1.5 billion, with a student body of about 1,400. So, we’re talking about over $1 million per student.

Some wealthy universities will probably avoid the tax in the near-term. Columbia, New York University, the University of Southern California and Johns Hopkins all have endowments over $3 billion. But their endowments fall below the $500,000 threshold. Columbia’s was worth $326,000 per student at the end of 2016. The university has 9,000 undergraduates and more than 23,000 graduates and professional students.

The ethical issue is whether it is fair to tax universities that exceed the $500,000, or tax any universities on their endowments for that matter. The motivation for the tax seems to be the belief, especially of Republicans in Congress, that many colleges and universities are building tax-favored endowments without using enough money to reduce tuition and support low-income students. Most colleges and universities dispute that and say diverting funds through the tax will only make it harder to enhance the financial aid.

The ethical problem is the system picks winners and losers, and that’s not the right way to go about accomplishing the goal. If Congress is concerned that universities and colleges are using too much to fund, let’s say, administrative salaries, faculty salaries, and support programs, then it should have simply required each institution with an endowment to devote a certain percentage to student financial aid and aid to low-income students. Alas, that would have been to simple for a Congress that seems bound and determined to make things more complicated.

There is an adage that says an ethical person (or organization) is one that “makes things better.” Congress pretty much always does the reverse. It’s disheartening that it has decided to create a financial barrier for universities with a large endowment but small student population. Did Congress ever stop to think the reason these schools have such a large endowment is they are well-respected by alumni and those who support their mission?

Blog posted by Steven Mintz, aka Ethics Sage, on January 23, 2018. Dr. Mintz is a Professor Emeritus from Cal Poly San Luis Obispo. Visit his website to find out more about his services and sign up for his newsletter.

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