Endowment Taxes and the High Cost of College

The recently enacted tax on the investment returns of highly endowed private colleges and universities affects a small -- albeit growing -- number of institutions, limiting proceeds and removing revenue generation as a plausible justification. The rationale behind the tax is largely based on the vast resources held by the affected institutions, their high cost and the underrepresentation of lower- and moderate-income students on their campuses. Tom Reed, a Republican congressman from New York, believes the tax will help promote “a good-quality education with an affordable price tag” at affected colleges and universities. But while important issues of access remain, the focus on price and affordability indicates a misunderstanding of the financial aid system and the tuition charged by these institutions.

Virtually all colleges that will be subject to the endowment tax fall into the category of institutions with “meet full need” financial aid policies. The idea is that any accepted student is provided with sufficient financial assistance to bring the cost of attendance in line with the family’s ability to pay. In practice, determining what a family can afford is difficult, and the family may still struggle finding those funds. But colleges that at least attempt to accomplish this goal are using their financial resources to support improved access.

A critical problem that these institutions face, however, is communicating their true price. The financial aid process is a daunting one, leaving many students in the dark regarding their actual cost of attendance. One survey indicated that around half of high school students only know college sticker prices, which can be upward of $70,000.

More colleges are acting to overcome this information problem. For instance, last April, 15 colleges adopted a simplified financial aid calculator that I developed, called MyinTuition. It provides estimates of college costs for students after factoring in financial aid based on just a few financial inputs that are readily known.

For instance, consider a student from a family with $75,000 in annual income, $25,000 in home equity (housing value less mortgage balance), $25,000 in savings outside a retirement account and $5,000 in cash (around the median values for families with high school-age children), as well as no siblings in college. As examples, plugging those values into MyinTuition for Dartmouth College and Rice University indicates that students probably would be expected to pay around $15,000 per year in tuition and fees, room and board, books, and personal expenses (including $2,500 in funding from a work-study job -- neither institution expects students to take out additional loans). Families with those finances are still likely to struggle to come up with that money, but it dwarfs the sticker prices, which are up to five times that level, far beyond what they could possibly afford.

Twelve of the 15 colleges and universities that have already adopted MyinTuition will be subject to the endowment tax. (One, the University of Virginia, is not subject to the tax because it is state supported.) More institutions will be adopting MyinTuition soon; most are likely to come from the list of those paying the endowment tax.

Overcoming misperceptions about price, though, is only one piece of the puzzle in improving access. Colleges and universities still should do a better job identifying and recruiting lower- and moderate-income students to apply and attend. Roughly two-thirds of students at many heavily endowed institutions come from the top 20 percent of the income distribution. And past research has shown that more academically qualified lower-income students are out there. More work clearly needs to be done, but efforts are already underway. The institutions subject to the endowment tax already partner with organizations like QuestBridge and Posse, which help recruit such students.

Meanwhile, the question is whether the endowment tax will accomplish its goal. If it is intended to increase access by encouraging colleges and universities to spend more from their endowment to lower their sticker price, it will be unsuccessful. The financial aid policies already in place at the affected institutions make the sticker price irrelevant for lower- and moderate-income students. Such institutions already have meet-full-need policies in place anyway. Perhaps it can push them farther down the path of expanded outreach.

The problem, however, is less about promoting the need for greater access than finding successful techniques to accomplish it. Colleges and universities must be more creative in identifying innovative strategies in that regard, but an endowment tax is a blunt instrument to accomplish that goal.