A Modest Proposal to Increase Access and Diversity at Elite Colleges
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- A new bill threatens to raise taxes on large university endowments.
- Some lawmakers claim wealthy universities are hoarding funds at the expense of students.
- Universities could consider increasing the payout rate of unrestricted endowments to fuel financial aid.
- Such a move could assuage lawmakers and result in more funding for low-income students.
As millions of Americans await student loan debt relief, U.S. House Republicans seek to punish universities for causing the debt crisis in the first place.
Wealthy universities with massive endowments are especially guilty, say lawmakers. They continue to hoard billions of dollars while raising tuition and not doing enough to provide access for low-income students. Now these institutions may be subject to a hefty tax increase.
But what if there were a way for these rich institutions to boost access and diversity, assuage politicians, and avoid this punitive tax measure?
Here's how that could be accomplished.
A Punitive Tax on Wealthy Universities
In September, only weeks after President Joe Biden announced his student loan relief plan, Congressman Dave Joyce (R-OH) introduced the Higher Education Accountability Tax Act, which sports the clever acronym HEAT. Mayra Flores (R-TX) who lost in the recent midterm elections, and Byron Donalds (R-FL) joined as co-sponsors.
The bill would raise the excise tax wealthy universities already pay. The 2017 Trump Tax Reform Plan levied a 1.4% tax on colleges with at least 500 students and more than $500,000 in endowment per student. Joyce's HEAT bill aims to increase this penalty to 10% and lower the per-student threshold to $250,000.
In 2019, the current tax formula applied to roughly 40 colleges. Using the HEAT calculus would swell that list by another 65 schools.
"Transferring $600 billion in student loan debt from one group of Americans to another does nothing to make education more affordable," Joyce said in a statement. "Instead, it incentivizes wealthy universities to continue driving up their tuition costs amid record-breaking inflation. These institutions need to be held accountable for their role in our nation's ballooning student debt."
What's more, Joyce and his colleagues claim institutions that meet these criteria and that increase the net price of attendance by more than the rate of inflation over a three-year period should face a 20% tax penalty.
These percentages pertain to endowment income, returns on investments gained each fiscal year. A similar bill, the "Ivory Tower Tax Act," proposed in 2021 by Sen. Tom Cotton (R-AR), would apply a 1% tax on the fair market value of each endowment. For Harvard, that would equate to $510 million.
Under the existing 1.4% structure, Harvard paid $49.8 million in federal taxes for the 2019 fiscal year. Stanford paid $42.9 million.
Republicans note that tuition and fees at top private universities have increased 134% over the last 20 years, while in-state costs at top publics have ballooned by 175%.
Meanwhile, endowments have mushroomed during that span. Harvard's largess grew from $17.5 billion in 2002 to today's $51 billion.
That latter figure reflects a 1.8% loss for Harvard in fiscal year 2022 (ending June 30), when college endowments dropped by a median of 10.2%. During the previous fiscal year, however, endowments grew by a median of 30.1%.
And the richest universities realized the highest returns in fiscal 2021. Washington University in St. Louis experienced a 65% gain. Duke University (56%), the University of Virginia (49%), and the University of Pennsylvania (41%) also added billions to their war chests in one year's time.
"Universities should be using these record gains to lower tuition and make higher education more obtainable for everyone," said Congressman Tom Reed (R-NY) in the wake of last year's results.
Increasing Endowment Spending to Fund Financial Aid
Perhaps there's a way they could.
Those unfamiliar with how an endowment works believe it's one large fund, a piggybank to be used however a university wishes.
In truth, an endowment consists of many funds, often thousands of them. Most of these individual funds are earmarked for certain purposes — scholarships, faculty support, academic programs, athletics, and so forth.
But a sizable percentage of the endowment remains unrestricted, meaning universities can determine how to spend the income generated each year.
In Harvard's case, for example, unrestricted funds account for almost 20% of its endowment, or roughly $10 billion. The university explains these funds are "more flexible in nature and are critical in supporting structural operating expenses and transformative, strategic initiatives."
Restricted endowments are governed by donor agreements, contracts that stipulate how the funds will be invested and spent. Unrestricted endowments aren't bound by such compacts.
"If the endowments are not legally restricted by a donor, there is institutional discretion as to management and spending," Susan Menditto, senior director of accounting policy at the National Association of College and University Business Officers, told BestColleges.
So if university officials can determine how to spend unrestricted dollars, can they also determine how much to spend?
Yes, they can.
It's a rather complex process, but suffice it to say universities aim for a spending rate of 4-6% of the endowment market value based on a three-year rolling average. About three-quarters of institutions use 5% as a target rate.
Universities have the flexibility to adjust that spending rate based on the economy and market conditions or during unusual circumstances such as the pandemic. The pool of money is limited, but institutions can realize more funds by increasing the payout amount.
What if, then, a university decided to dedicate an additional 2% of only its unrestricted endowment — not the donor-restricted funds — each year toward financial aid? Would that make a meaningful difference for students?
Using 2021 endowment figures, a 2% increase in unrestricted endowment spending at the University of Pennsylvania (Penn) would have yielded an additional $206 million that year. At the Massachusetts Institute of Technology (MIT), $160 million. At Notre Dame, $146 million. And at Northwestern, $111 million.
At MIT, that translates to an additional $58,000 per aided student. For Penn, it's $47,000. At Notre Dame, $34,000.
Spending just another 2% of only the unrestricted endowment, which these universities have the latitude to do, could open doors for thousands of students.
"A lot of these schools have room to spend more from their endowments," Charlie Eaton, a University of California, Merced sociology professor, told The Washington Post. "If they enrolled more students from low-income backgrounds, they could make a further contribution to equity."
Why won't they do it?
Universities Accused of 'Hoarding' Funds
One reason they don't is that universities prefer to keep their gaze locked on the long-term horizon, remaining fiscally conservative to ensure future viability. They adhere to the "Uniform Prudent Management of Institutional Funds Act," which details best practices for "the preservation of the endowment fund."
"The thought is that the approach of staying the course does yield enhanced opportunities over time for growth," Menditto said.
Raising the spending rate would reduce the amount a university could reinvest in the endowment's corpus to hedge against inflation. Spending more today means they can spend that much less in future years.
This rationale fails to convince skeptics, including lawmakers, when universities are experiencing double-digit returns and tripling their endowments over two decades. Many claim these wealthy institutions are simply hoarding funds for the wrong reasons.
And it's not just an opinion. It's been empirically proven.
In a 2014 American Economic Review article, Jeffrey R. Brown et al confirm the "endowment hoarding" phenomenon. Endowment size represents a "symbol of status and prestige," they posit, and university leaders are evaluated and compensated in part based on endowment growth.
Similarly, in a 2022 National Bureau of Economic Research paper, George Bulman, an economics professor at the University of California, Santa Cruz, examines how rich colleges spend additional money when their endowments grow.
Do students benefit by receiving more financial aid?
Bulman found universities spend only about 10% of additional funds on aid. The rest goes to "improving the student experience" so they can attract more applicants and "become a more selective, more prestigious version of themselves," he told BestColleges.
"They could have basically been making the institution free for anyone who's eligible for financial aid while still remaining incredibly rich …," Bulman said. "And the reason they weren't doing it on their own is because their objective function has more to do with prestige … rather than maximizing access."
Assuaging Politicians With a Win-Win Solution
Facing such stiff political headwinds, might it be wise for wealthy universities to take preemptive measures to ward off potentially punitive tax hikes that appear perched on a slippery slope? Today, a 1.4.% rate; tomorrow, perhaps 10%, or even 20%. And beyond that?
Universities could convincingly position this 2% strategy as a win-win. Bills aimed at taxing endowments claim universities aren't doing enough to support students. Yet it's entirely unclear what the government does with the millions of dollars it collects. Do those funds find their way back into student pockets? It's highly unlikely.
So it's actually counterproductive to take money away from universities while asking them to spend more on financial aid. University leaders have argued that taxing endowments impacts their ability to support low-income students.
Instead, what if the universities could retain those tax dollars and dedicate an additional 2% toward aid? More students get more money, and everyone's happy.
It would require some careful accounting on an institution's part to create separate spending allocations for just unrestricted funds, but it certainly seems feasible. And once pledged to the 2% solution, universities would have to prove fealty to the concept and not reallocate funds already earmarked for aid.
"You'd have to have some oversight to make sure the fungibility concern doesn't rear its head," Bulman said.
Could this solution work? Theoretically, yes. Is there much chance it gets adopted? Not really.
Universities are loath to tinker with time-tested investment strategies, and permanently raising payout rates — albeit only on unrestricted funds — might appear heretical, even if it benefits students.
Meanwhile, endowment managers at wealthy institutions rake in millions of dollars annually for padding the university's pockets, earning far more each year than what their employers spend on student aid.
But here's an opportunity for these rich institutions, which consistently espouse access and inclusion and tout their commitment to making higher education affordable for low- and middle-income families, to put their money where their mouth is.