University Endowments

(Bloomberg) -- A not-so-old joke has it that Harvard is best thought of as a hedge fund with a university attached. The money in question is its endowment, a pool of some $37 billion made up largely of donations and retained earnings from investments. Big college endowments are a mostly American phenomenon, the product of a culture of philanthropy, rising inequality and aggressive investment techniques. Endowments long benefited from tax breaks for donors and a tax exemption on a fund's earnings. Critics have been asking whether endowments are doing enough to help students at a time of soaring educational debt — or if the support by taxpayers is just helping the richest schools get richer. The new tax bill passed by Congressional Republicans and signed by President Donald Trump takes aim at some of the biggest endowments. 

The Situation

The tax overhaul includes a 1.4 percent tax on an endowment's annual investment earnings. It applies to private colleges with assets of more than $500,000 per full-time student. About 30 institutions meet that critieria, including large research universities including Harvard, Yale and Princeton and some smaller liberal arts schools such as Amherst, Williams and Grinnell. The tax is expected to raise about $200 million a year. During the 2016 campaign, Trump had said he wanted to make sure that colleges getting “these special federal tax breaks” were making “good-faith efforts to reduce the cost of college and student debt.” Congressional scrutiny of endowments is not new: In 2016, two Congressional committees had asked the richest 56 private schools to provide details about how they spend endowment returns and pay fund managers. U.S. college endowments rebounded in fiscal 2017 from disappointing results the year before. Outside the U.S., endowments are far smaller. In the U.K, Cambridge has an endowment of ‎2.2 billion pounds ($2.8 billion), and Oxford one of ‎2 billion pounds. Other schools with big endowments include the King Abdullah University of Science and Technology in Saudi Arabia and the National University of Singapore.

The Background

Endowments have long played a central role in the rise of some colleges. A $17 million bequest in 1932 from George Eastman, the inventor and founder of Eastman Kodak, helped make the University of Rochester one of the nation's richest for several decades. Donations of $100 million or more have come in a flurry in recent years, with about a dozen received by universities in 2014 and 2015. Endowments have also grown by adopting aggressive investment techniques. In 1985, 65 percent of Yale's fund sat in U.S. equities; its asset allocation target for domestic stocks in fiscal 2016 is 4 percent. Its pioneering chief investment officer, David Swensen, described an endowment's long time horizon as “well suited to exploit illiquid, less efficient markets.” Other universities followed suit, and returns rose. Then came the 2008 downturn, when the lack of liquidity contributed to some big losses. Harvard's fund declined 27 percent. Today, some schools with big endowments and smaller student bodies, such as Princeton, Amherst and Grinnell, derive about half their operating budgets from endowment income. About 800 U.S. universities had a combined $515 billion in endowment assets as of June 2016, according to an industry survey. 

The Argument

A Congressional Research Service report estimated that the cost of tax deductions claimed by individual and corporate donors to universities amounted to $6.3 billion per year. Both benefits flow largely to elite schools. One advocacy group estimated that the $6 billion a year needed to fund former President Barack Obama's proposal to make community college free could be raised by a sliding-scale excise tax of between 0.5 percent and 2 percent on endowments that exceed $500 million. Colleges have countered that they can't spend their funds like money in a bank account. Endowments are comprised of thousands of individual funds derived from gifts, and schools must by law follow the intention of the donors. The university community vehemently protested against the tax added in the new bill.  Ted Mitchell, president of the American Council on Education, a higher education trade group, described it as taking money from students and faculty to fund corporate tax cuts, which he called “a remarkably bad idea.”

The Reference Shelf

• The yearly survey of endowments and investment returns by the National Association of College and University Business Officers.
• A Congressional Research Service report on endowments and tax options.
• Annual reports from the Harvard and Yale endowment managers.
• An American Institutes for Research study suggests taxing large endowments to support low-income students at public and community colleges.

First published Feb.

To contact the writer of this QuickTake: Janet Lorin in New York at jlorin@bloomberg.net.

To contact the editor responsible for this QuickTake: John O'Neil at joneil18@bloomberg.net.

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