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University endowments in the crosshairs

December 11, 2017

By Charles Skorina

The U.S. has the greatest university system in the world.  But it’s expensive.  And congress is about to make matters worse by taxing the endowment earnings of “large” private college and university endowments.

The latest congressional proposal aims to slap a 1.4 percent excise tax on the net investment income of any private university with an endowment of more than $250,000 per full-time student, about 70 universities.

Unfortunately, universities can ill-afford any additional hits to the bottom line.  A recent report by The College Board, What's the Price Tag for a College Education?, found that a "moderate" college budget for an in-state public college for the 2016–2017 academic year averaged $24,610 and a moderate budget at a private college averaged $49,320.”

Private universities in particular lean heavily on their endowments for tuition assistance and operational support.  Melissa Korn noted in a Wall Street Journal article earlier this year, Private Colleges See Record Discounting Amid Pressure From Cost-Conscious Families, that “schools with endowments over $1 billion funded just over one-third of institutional grant aid from their endowments, while those with endowments of less than $25 million used that pool to cover 5.8% of aid”.

Endowment pools are like savings accounts and endowment earnings the interest.  The more we draw from savings to spend today, the less money we earn to spend tomorrow.  We all learned this lesson in household economics, but congress apparently missed that class.

Two years ago, we wrote Rebutting the endowment critics in defense of the Yale endowment:

Endowment capital is a perpetual source of support for present and future generations of students and faculty and, it takes a long time to accumulate.

Cambridge, the wealthiest university in Europe, took 800 years to amass an endowment of $8.1 billion.  Harvard's $36.4 billion took 377 years to accrue.  Upstart Stanford University grew its endowment to $21.4 billion in "just" 130 years.  And that "hoarded" wealth drove performance; American universities dominate the rankings of global higher education.

Unfathomably, the latest congressional proposal to tax the earnings of “large” private school endowments turns that reality on its head.  The legislative war cry now seems to be “grab what you can today and let future generations fend for themselves”.

There are four sources of income for American universities and colleges and all four are under pressure.  State and federal support has been dropping for years, endowment investment returns appear likely to decrease, tuition costs have reached unsustainable levels, and donor gifts have flatlined.

And that may not be the worst of it.  Clayton M. Christensen, the Kim B. Clark Professor of Business Administration at Harvard Business School (ironically, it’s an endowed chair!), sees half of America’s 4000 colleges and universities going bankrupt in the next decade or two, Harvard Business School professor: Half of American colleges will be bankrupt in 10 to 15 years, as online education “disrupts” the business models of traditional institutions and runs them out of business.

Our system of higher education – including the great private universities – has been a key asset in our national preeminence.  Financing that system is a growing challenge, but taxing endowment earnings or forcing unwise spending mandates on a handful of successful institutions will only aggravate the situation.

We closed our Yale piece by saying:

Universities began in medieval Europe as autonomous, self-governing communities of teachers and students.  The independence of private universities, once lost, will be hard to retrieve.  Being left alone to manage gifts from their private, voluntary supporters under their own governance, for their own various purposes, would seem to us a minimum component of such independence.

Channeling private wealth to public purposes, instead of relying solely on the whims of a benevolent state as in Europe, has been an American success story.  We hope Congress doesn’t spoil the ending.

Charles Skorina works with leaders of endowments, foundations, and institutional asset managers to recruit Board Members, Executives Officers, Chief Investment Officers and Fund Managers. Mr. Skorina also publishes The Skorina Letter, a widely read professional publication providing news, research and analysis on institutional asset managers and tax-exempt funds. Prior to founding CASCo, Mr. Skorina worked for JP Morgan Chase in New York City and Chicago and for Ernst & Young in Washington, D.C.

The views expressed here belong to Mr. Skorina and do not necessarily reflect those of the CAIA Association.