Taxes on college endowments: Their time has come in Connecticut

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Yale Old Campus Courtyard in early spring.

Last month I testified before the Finance, Revenue, and Bonding Committee of the Connecticut General Assembly on Senate Bill 413. The bill aims to encourage Yale University to spend more of its enormous endowment earnings on improving what it currently does for low-income students and its surrounding community. Unfortunately, reporting from the Courant and elsewhere has recast the bill as an answer to the state’s budget woes. In doing so, the media misrepresents the bill’s intent.

It is true that some of Yale’s endowment gains would be potentially subject to a tax that would go to the state. However, the expected effect of this bill is to incentivize Yale to limit the amount it might owe by setting aside more of its endowment gains for appropriate educational concerns and community responsibilities.

If Yale chose to not spend more on those initiatives, the earnings it reinvests would be subject to the Unrelated Business Income Tax of 7 percent. Yale would then keep 93 percent of what it returns to its investment funds, while the endowment itself, as well as all of its other sources of income, would remain 100 percent tax free. Consequently, if this bill is successful, rather than seeing a major windfall, the legislature would at most see only a modest gain in revenue.

That said, why propose such a tax plan? The question is one of improving on fairness through judicious revisions of current tax codes so that more effective use can be made of large college endowments. To that end the Senate Finance and House Ways and Means Committees of Congress have asked institutions with endowments of over $1 billion to respond by April 1 to a questionnaire on how these funds are used to serve the public good.

In this context, last year we published a study, Rich Schools, Poor Students: Tapping Large University Endowments to Improve Student Outcomes, that examines why a tax on endowments is a tax whose time has come.

Our study shows that not all private universities are truly private. Many of the richest universities in the country, sitting on billions of dollars in tax exempt endowments, receive through the tax laws government subsidies that greatly eclipse the appropriations received by public colleges.

For example, Yale’s tax exempt status generates over $69,000 per student each year in taxpayer subsidies, compared to the $23,300 per student subsidy at the University of Connecticut, or the $6,700 per student at Central Connecticut State University, or the $6,200 per student at Tunxis Community College.

The study also shows rich schools receive large tax-generated subsidies but enroll a disproportionately small share of low-income students. This leads to a perverse pattern wherein the richer the school, the lower the percentage of low-income students served. For example, in the case of Yale only 13 percent of full-time first-time undergraduates receive Pell grants, whereas 18 percent of UConn and 34 percent of Central Connecticut State University students receive Pell grants, while nearly 50 percent of those enrolled at Tunxis Community College receive these grants for low-income students.

In effect, given that affluent private schools educate a far lower percentage of low- and middle-income students than public institutions, in many cases the average Connecticut taxpayer is subsidizing the education of students in the well-endowed, more selective schools to a far greater extent than they are supporting the education of their own children, most of whom attend broad-access public institutions. In other words, the majority of taxpayers are poorly served by the tax-exempt status of large college endowments. And providing a public benefit is the purpose of granting tax-exempt status to private nonprofit institutions.

Lastly, we examined how a more equitable tax code could tap large university endowments to improve student outcomes. To the extent that SB 413 does produce income for the State of Connecticut, I would encourage legislators to use those funds specifically to improve the outcomes of students in Connecticut’s system of public higher education, which is suffering from significant funding cuts.

In sum, we believe hidden tax subsidies that increase inequality are not good policy. In contrast, SB 413 is reasonable in scope, fair in its goals, and represents advancement well within the current public policy thrust aiming to reassess the tax codes to help address America’s need for an educated citizenry and a qualified workforce.

Dr. Jorge Klor de Alva is the president of Nexus Research and Policy Center and a former professor at Princeton University.

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