The Rich University: The Mother of all Tax Breaks
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The Fiscal Times
October 7, 2011

For elite private U.S. universities with large endowment funds, fiscal 2011 was a very good year.  After suffering a 30 percent decline in its endowment in 2008, Harvard University reported last month that its fund—the largest in the country—grew by $4.4 billion to $32 billion last year, reaping the university a 21.4 percent return on its investments.  The high returns have some economists, lawyers, and even some lawmakers, questioning the merits of continuing to give deep-pocketed universities tax breaks at a time when federal and state budgets are starved for revenue. 

Stanford, Yale, the University of Pennsylvania, and Massachusetts Institute of Technology also posted gains of 22 percent, 21.9 percent, 19 percent, and 17.9 percent, respectively, in the fiscal year that ended June 30.  Other Ivy League schools also saw strong returns.

“At some point, a nonprofit gets so rich that it seems kind of obscene to let wealthy universities get out of paying taxes,” said James Miller, an economics professor at Smith College. “Especially with this new Super Committee, I think the federal government is going to start looking a lot harder at the revenue running out the door every year—especially to institutions like Harvard that don’t exactly need it.”

Like most non-profit organizations, universities pay no property tax, which has led to an unprecedented legal challenge in Princeton, New Jersey.  According to N.J.com, the University is being sued by a group of local residents who argue that Princeton owes property taxes on nearly 20 buildings not directly related to classroom or educational activities.

“…the university is not paying its
fair share of taxes and thus
homeowners in the borough are
shouldering a larger burden
than they ought to be.”


Princeton lawyer Bruce Afran told N.J.com, “Activities take place in those buildings, both profit-making activities and non-educational activities, that the state legislature never intended to be tax exempt. The result is that the university is not paying its fair share of taxes and thus homeowners in the borough are shouldering a larger burden than they ought to be.”

Universities like Harvard have multiple revenue streams:  tuition, room and board, unrestricted alumni giving , ancillary revenue from sporting events, book sales, royalties, and other material, and, of course, the big one--the endowment.  University endowment funds—supplied with capital from tax-deductible contributions —help pay for scholarships and tuition assistance, faculty salaries, upkeep of facilities, new research projects, or virtually any endeavor the university’s administration decides.  But the fund can also pay a college president and other administration officials exorbitant incomes and benefits.  

Yale University president Richard C. Levin made a base salary of $1,181,032, not including health care and other benefits, free housing, transportation, cleaning services, gardening, travel & entertainment expenses, and the like. Duke's head basketball coach, Michael Krzyzewski, made $3,763,373 in 2009.  Of course, Duke and other universities run their athletic departments as profit centers, with revenues from television, ticket sales, clothing, and memorabilia.   Massachusetts universities are awarding dozens of key administrators extravagant half-million-dollar or more pay packages, according to a report released last month by the Tellus Institute, a nonprofit research and policy organization aligned with unions. 

 

Endowment funds are typically compromised of thousands of smaller funds established by individual donors.  But once that money is donated, it is invested in a mix of stocks, bonds, private equity funds, hedge funds, and real assets at home and abroad.

As nonprofits, those investment returns are exempt from the 15 percent capital gains and dividends tax private companies, investors, and individuals pay on investment income  -- so long as that income is used to further the university’s tax-exempt function, in this case education.  Universities, like all nonprofits, are also exempt from paying federal corporate income taxes, and state and local sales and property taxes. 

Large university endowment funds have advantages over individual and private investors, according to a 2010 Wells Fargo report.  They have the benefit of holding investments indefinitely, have few liquidity constraints, and as a result, can take on more risky investments.  “Larger institutions in particular benefit from access to the best managers, alternatives such as natural resource partnerships that are unavailable to individuals, and the lowest fees and trading costs,” the report said.