Proposal to Tax University Endowments All Mixed Up

A state proposal to tax university endowments in excess of $1 billion at 2.5% per year appears to be gaining a little bit of steam, according to an article in the Boston Globe this morning.

Critics of the institutions of higher education point to their massive endowments -- especially Harvard University's $34.6 billion -- as out-of-line with their mission and managed in a way that, for all intents and purposes, looks like a for-profit corporation. Harvard's endowment now exceeds the $28 billion annual operating budget of the entire state government.

The proposal to tax the endowment funds greater than $1 billion, however, is particularly odd because for-profit corporation taxation is usually based on income or earnings -- not on the value of the capital itself. Harvard earned nearly 20% return on their endowment investments last year, resulting in a profit of approximately $6 billion; taxing those earnings at the capital gains rate would seem to be a more credible proposal than taxing the endowment itself.

A rule-of-thumb for non-profit endowments is that they ought to be spending roughly 5% of their endowment per year, otherwise they are hoarding money rather than operating in the public interest. A 10% return on their endowment can be considered then as a reasonable way to allow for modest growth of 5% (after the 5% expenditure is removed). Most universities have, in recent years, earned a little bit more than this rate of return.

How about if the state legislature considers a different law: tax earnings in excess of 10% at the capital gains rate of 15% on endowment capital exceeding $1 billion? That would mean that 10% of Harvard's 20% return on $28.7 billion in 2007 would be taxable at a rate of 15%, resulting in a tax payment of $831 million. It would be the non-profit equivalent of a windfall profits tax.

I am not claiming that such a state law would be a good idea, but it would at least make more sense from a tax perspective than the proposal to tax endowment capital itself that was mentioned in the Globe article. The "endowment windfall profits tax" would protect smaller institutions with endowments under $1 billion, and would not tax institutions when they have poor investment returns for the year.


Image by Tracy O provide by a Creative Commons license.


UPDATE: CNN's right-winger Glenn Beck seems to have picked up the term "endowment windfall tax" without attribution. He must be a reader of Brighton Centered.