Taxing Endowments

Note to Congress: Create Incentives, Not Taxes

A change in Congress’s proposed excise tax provision could encourage institutions to use their resources to educate more talented low- and middle-income students, argues Catharine B. Hill.

December 12, 2017
 
 
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The U.S. House and Senate are working to reconcile their tax proposals, each of which includes an excise tax on high-endowment, private, nonprofit colleges and universities. The fact that such a tax on endowments appears in both bills suggests it is going to become law if the reconciled bill passes Congress. But rather than taking those resources away, the conference committee should propose a new version of the tax, one that changes the incentives facing those institutions.

The current Senate proposal would apply to colleges with more than 500 students and endowments per student greater than $500,000, and would affect about 26 institutions. The current House version has an endowment-per-student cutoff of $250,000 and would add roughly an additional 40 institutions to the list. An excise tax will force those institutions to reduce spending or find ways to increase revenues to offset the loss from the excise tax. Faced with reduced resources, they will have to make decisions about cutting something. Will it be research funding, financial aid to students, the academic program -- or all of the above?

Reduced resources for public higher education from strained state appropriations have led to increases in tuition, which would be another alternative for these colleges and universities, since many families of students competing to attend them are willing and able to pay the tuition. It is very likely that many of the private institutions affected by the endowment tax would choose some combination of all the options, balancing competing priorities and the downsides of these alternatives on the margins. As a result, reducing need-based financial aid would be part of the response -- only one of several unintended, shortsighted and damaging consequences.

The final Senate bill exempted one additional college from the excise tax, and it was not Hillsdale College (with that amendment being defeated). Adding two words, the Senate amended the House’s definition of “applicable educational institutions” from ones with at least 500 students to ones with at least 500 tuition-paying students. With that change, Berea College, which otherwise would have been subject to the excise tax, becomes exempt.

Berea only admits students from families with incomes in the bottom 40 percent of the income distribution and charges them no tuition. If the goal of this exemption is to recognize the value of making a quality education available to talented students from the bottom 40 percent of the income distribution, why not structure the proposed excise tax in a way to encourage all of the other targeted colleges and universities to offer admission and free tuition to more students from the bottom 40 percent of the income distribution? Legislators could use Pell as a measure: students who are eligible for Pell Grants are a good proxy for students from this part of the income distribution.

Assuming policy makers want this group of colleges and universities to admit more students from this demographic, they could exempt other institutions on the list from the proposed excise tax if their share of Pell Grant students exceeded a certain level. Currently, the share of Pell Grant recipients at the colleges and universities that would be subject to the excise tax in the Senate version ranges from 7.4 percent to 22.5 percent. If the approximate amount of revenue that would be taken away from these institutions through the excise tax were instead used for need-based financial aid for additional Pell Grant recipients, approximately 5,000 more students could be supported through financial aid, increasing their number of Pell Grant recipients by approximately a third, and their average share of a college or university’s student population from about 15 percent to 20 percent Pell. (Note: This assumes a long-run average return of 8 percent and institutional grant aid per Pell student of about $40,000.)

Alternatively, the excise tax could be implemented on a sliding scale, depending on an institution’s share of Pell Grant recipients and the net price that students are asked to pay. These options, rather than taking resources away from higher education, would create incentives for wealthy institutions to use their resources to educate more of America’s talented low- and middle-income students.

Many of these same colleges and universities are already committed to educating a more socioeconomically diverse student body and have been hard at work on this for years. A majority of the institutions on the Senate list are committed to the American Talent Initiative, working to increase the access and success of talented lower- and middle-income students by 2025. A change in the excise tax provision could encourage additional colleges and universities to make similar commitments, contributing to the public good by increasing economic mobility through education -- long an important component of the American dream.

Bio

Catharine B. Hill is managing director of Ithaka S&R and president emerita of Vassar College.

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