Goldie Blumenstyck reports in the Chronicle of Higher Education (paid access) that several economists have proposed requiring higher education institutions to use five percent of their endowment each year for educational purposes. Arguably, the requirement might be extended over a longer period. For instance, there could be a requirement that colleges use 5% of their endowment over a twenty year moving average. However, colleges should be required to use their endowments for educational purposes.
In reply, higher ed associations argue that they should not have to use their endowments and that the endowments are not like bank accounts. The Chronicle notes:
"Lynne Munson, an adjunct fellow at the Center for College Affordability and Productivity, and Jane G. Gravelle, an economist at the Congressional Research Service—each recommended at the hearing that Congress enact legislation to require colleges with endowments worth $1-billion or more to spend at least 5 percent of that money each year, as private foundations are required to do, or be subject to federal taxes (The Chronicle, September 27)."
I would cut the minimum to ten million dollars. Colleges are not investment funds. The money should be used for educational purposes, not to protect institutional privileges.
Yet, the Chronicle reports that "the American Council on Education, the Association of American Universities, and the National Association of Independent Colleges and Universities, said that the proposal does not take "complexities into account", such as legal restrictions on the use of endowments.
I would argue that Congressional oversight of the use of endowments is a good idea. Part of section 501(c)(3), the federal law that regulates the tax exemption of universities, requires that assets be used for tax exempt purposes, not for the benefit of the administrators and faculty of institutions. As well, this might be a first step toward increased congressional scrutiny of the politicization of universities, which is not permitted under section 501(c)(3). That is, violations of the tax exemption requirements for university trust funds are an open secret about which universities are inclined to lie. Increased congressional scrutiny might include beginning to require that universities divulge actual student outcomes; improvements in knowledge based on objective knowledge and general skills tests; job placement; graduate school admission; faculty research output; and student engagement on campus.
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Is endowment or investment management truly part of the "tax-exempt-purpose" as defined in the tax code. I would argue no. It is time to tax universities similarly to the Accumulated Earnings Tax for private corporations.
A back of the napkin calculation shows that just 30% of the earnings of these endowment could fully fund the entire undergraduate student body (i.e. avg annual tuition $35,000 per year at Yale) which would still leave a very respectable 10-12%+ annual rate of return.
Consider that a such a tax on endowments could contribute substantially to closing the so-called tax-gap of $300 B per year. I'd suggest that it is the preferential treatment of universities so modified per above could almost entirely eliminate it. The remaining two thirds could be used as they are now, 1/3 being transferred to the university fund as it is now, with the final 1/3 left as retained earnings, sorry, "net fund balance," a wonderful euphemism for tax free profit.
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