Verbum Ultimum: Endowment Tax Conundrum

The Republican tax plan will hurt colleges — and their students.

by THE DARTMOUTH EDITORIAL BOARD | 1/5/18 12:30am

Last month, Congress signed a sweeping new tax bill into effect. Allegedly designed to benefit the middle class, this bill includes a 1.4 percent excise tax on the investment income of private colleges and universities with at least $500,000 in assets per student, which will likely come primarily from schools’ endowments. Dartmouth, along with over 30 other wealthy private schools ranging from Harvard University to Swarthmore College to the Cooper Union for the Advancement of Science and Art, will likely be affected by this tax, which is expected to bring in about $1.8 billion over a decade and help offset the large increases in the national debt the tax bill is expected to produce.

The excise tax will supposedly encourage the affected colleges to move more of their endowment funds into programs beneficial to students, such as financial aid. This reflects a thought that if a college were to sustain a fund that isn’t being used for students, then the money should be taxed. By taxing investment income, this bill could theoretically encourage schools to channel more of their money into financial aid, which would remain untaxed. Proponents may also hope that the Department of the Treasury, which would be receiving the tax revenue, would redirect funds toward federal scholarships or other initiatives for students, though the bill does not mandate such action.

As with most recent legislation, the excise tax has been tainted by accusations of partisanship. Democrats argue that it targets universities that are generally viewed as hostile to conservatives. Previous versions of the bill also included language that would have exempted schools that have ties to prominent Republican leaders, such as Berea College and Hillsdale College. Republicans can counter that Democratic backlash is also partisan, since Vermont Sen. Bernie Sanders led the charge by Senate Democrats to remove an exemption that would have benefited Berea, a tuition-free college in Kentucky that enrolls eligible low-income students, from the bill. Berea will now have to pay an estimated $1 million per year in taxes, which Berea President Lyle D. Roelofs has said will likely force the school to turn away potential students.

Regardless of its potential underlying motivations, the excise tax is flawed because it will harm the students it purports to help. While Berea may be an unintended victim of the bill, it is not alone in losing out. The reality is that taxing wealthy private colleges and universities is unlikely to increase financial aid and may actually restrict the amount of financial aid that future students receive. Because the bill taxes investment income, it takes away money that has potential for sustained endowment growth. If colleges were to move this money into financial aid, as the bill’s writers seem to hope they will, they would thus lose out on the additional income they could have gained had it stayed in investments, which could have been used to benefit more students in the future.

The tax’s impact on Dartmouth may not be nearly as large as its impact on Berea. Mike Wagner, the College’s chief financial officer, said it is unlikely that Dartmouth will decrease its scholarship offerings as a result of the bill. Even so, the tax will make it steadily more difficult to increase financial aid and full scholarship packages to students. Wagner estimates that if the tax had been in effect over the past five years, the school would have had to pay roughly $5 million more in taxes per year, or $25 million in total. And the true cost would be even greater, since this money would have been compounding and generating more revenue over the years. In limiting the potential growth of Dartmouth’s endowment, the tax could therefore take away money that supports expenses for future students, including financial aid, research, student activities and professor salaries, according to Wagner.

It is important to assess the current ability of wealthy colleges to provide financial aid as well. Harvard, which has the largest endowment in America, currently provides full tuition to over 20 percent of its students. Since its undergraduate population alone is composed of roughly 6,700 students, this means that Harvard fully supports the education of about 1,340 students each year. And Harvard is just one of the approximately 30 colleges targeted, each of which is able to use its endowment to provide financial aid to deserving students.

It is true that these schools, including Dartmouth, can afford to do much more to directly support their students and increase access to a greater number of students. Stanford University, for example, has increased its endowment tenfold but maintained its yearly enrollment of about 1,600 new freshmen since 1970. Several Ivy League schools have followed similar trajectories. But if legislators truly want to help students, they have to do more than simply tax existing funds, especially since there is no language that the new revenue will be required to go toward education expenses. There is a legitimate argument to be made for a less exclusive system of education that seeks to expand access to high quality schools, but this bill does not do that.

One way for Congress to achieve this goal is to mandate that a certain percentage of investment income be reserved for financial aid and similar purposes. This would not only ensure that a large percentage of endowment income directly serves students but also allow these funds to continue to grow. As it stands, however, this tax seems like much more of a slap in the face for wealthy higher education institutions and less of a guarantee to help students.

The editorial board consists of opinion staff columnists, the opinion editors, the associate opinion editor, both executive editors and the editor-in-chief.