How Higher Ed Taxes the Poor and Gives to the Rich

Why do the richest colleges and universities providing education to the smartest and most affluent students get the biggest tax breaks? More and more people — both on the left and right ends of the ideological spectrum — are asking that question.

Controversy is sure to grow with the release  of a study, “The Ivory Tower Tax Haven: The state, financialization, and the growth of wealthy college endowments,” by Charlie Eaton with the Haas Institute for a Fair and Inclusive Society at UC Berkeley. Eaton argues that private colleges with substantial endowment wealth have become “ivory tower tax havens,” creating “islands of privilege” that perpetuate social and economic stratification.

Since the 1970s, elite universities have benefited from three big tax benefits: (1) tax deductions for donors giving to endowments, worth about $1.2 billion in 2012, (2) the non-profit exemption of endowment investment returns, worth about $12.9 billion; and (3) municipal bond tax exemption for higher education, worth about $5.5 billion. The total benefit in 2012: about $19.6 billion.

Per-student spending from endowments, 1976 to 2012, broken down by endowment wealth per student. Graphic credit: “The Ivory Tower Tax Haven.”

The result has been a growing disparity in resources and expenditures per student. For U.S. undergraduate-enrolling institutions in the 99th percentile for endowment wealth per student,” writes Eaton, “annual spending per student from endowments increased by 751% to a mind-boggling $92,736 between 1977 and 2012. … Public universities and less wealthy private schools saw no comparable increase in resources from endowments or other areas of support.”

Who benefits from this increase in spending? Rich kids mostly. Elite schools with the biggest endowments enroll the wealthiest kids. Recent research shows that 38 of the most elite schools in the U.S. enroll more students from the top 1% of the income spectrum than from the bottom 60% combined.

Prior to the 1970s, the logic behind tax exemptions for higher education was “to protect intergenerational equity by providing comparable levels of effort towards the university’s mission from one generation to the next,” writes Eaton. Over the years, colleges and universities have used the tax breaks instead to maximize the size of endowments and increase instructional spending per student, thus enhancing institutional prestige.

One commonly pursued strategy is to retain and reinvest income from endowments rather than spend it. Since 1990, the average investment return for what Eaton classifies as “wealthy endowments” has been 10%, but spending amounted to only 5%, leaving the balance to be applied to asset growth.

Another strategy has been to engage in indirect tax arbitrage, in which universities direct donations to endowments rather than operational spending or non-financial capital investments. Universities can make more money by investing their endowment wealth than they lay out in payments on tax-free municipal bonds.

Rather than using the income to increase enrollment, elite private universities have preferred to increase instructional spending per student. “Flat enrollment makes sense,” writes Eaton, “because low admission rates to undergraduate programs tend to improve schools’ position in college and university rankings.”

Eaton lists 24 private institutions with large endowments. Most are located in the Northeastern states, but two are located in Virginia. Washington & Lee University, with a $2.2 billion endowment, had endowment spending per student of $27,000 in 2012. The University of Richmond, with a $1.9 billion endowment, had $24,000 in spending.

Bacon’s bottom line: Eaton’s work shows how universities behave rationally from the perspective of prestige-maximizing, not profit-maximizing, institutions. Ten percent of the U.S. News & World-Report “Best Colleges” ranking algorithm comes from average per-student “instruction, research, student services and related educational expenditures.” Another 12.5% is determined by student selectivity. Thus, higher-ed institutions have an incentive to build their endowments, lavish large sums on student instruction and services, and keep enrollments small and selective. Which is exactly what most have done.

As regular readers know, I do not favor punishing the rich through increasing tax rates. The rich already pay a hugely disproportionate share of income taxes, and high tax rates distort economic behavior to the detriment of all. But neither do I favor heaping additional privileges upon the wealthy. Anyone who wants to create a more egalitarian society, as I do, would do better to focus on the $20 billion a year in annual subsidies for wealthy colleges.

Real change must come from Congress because the special tax treatment originates mainly from the federal tax code. But from a Virginia public-policy perspective, perhaps it is worth examining the repeal of state breaks for contributions to higher-ed endowments, income generated by endowments, and university municipal bonds. Do we, as polity, really deem it a priority to subsidize the education of the wealthiest among us?

There are currently no comments highlighted.

2 responses to “How Higher Ed Taxes the Poor and Gives to the Rich

  1. Well this falls in the area of Charitable Deductions – and the general rule is that an organization must be non-profit, engaged in some “socially beneficially” activity and that includes a plethora of groups ranging from Churches to Schools to hospitals to think tanks to even Dark Money groups.. and the IRS has taken it on the nose when it tried to restrict some groups engaged in overtly political activities from getting that designated that allowed anonymous donors to receive tax deductions and the money to actually be used for political activities…

    I don’t really begrudge the wealthy from donating to higher ed endowments.. and I don’t think it really “hurts” the “poor” who are accommodated in other ways , so I’m a little suspicious that this is just another variation of the whining about the middle class not getting “affordable” college because all these rich dudes are funneling money to colleges who are using it in ways that does not lower the cost of tuition – for the middle class.

    I don’t think cutting off that money from the rich will have any effect, what-so-ever on the cost of tuition.. call me a skeptic on that..

  2. State schools do not need endowments. The large subsidies from our tax dollars is the equivalent of an endowment. In fact, small private colleges have difficulty competing with state schools because the tax dollars allow high salaries, benefits, etc. The small private colleges need high tuition costs to pay competing salaries, benefits, etc. Few can afford the high tuition of small private colleges.

Leave a Reply