How a tax on university endowments can help reduce our labor shortage

A growing number of Americans are fed up with universities, especially elite private ones. A recent article in a widely read publication captures this mood: “America’s elite universities are bloated, complacent and illiberal.” This irritation has led some critics to raise questions about the size of the endowments of the richest universities and how leniently they are treated in the nation’s tax code. Only a handful of these huge endowments are even minimally taxed and the contributions that built them are tax deductible for donors.

As resentment mounts toward these super rich schools, the key question is once again front and center: Why is Harvard’s $51 billion endowment nearly free from taxes?

This is not the first time the issue of taxing university endowments has been raised. In 2015, we published a report “Rich Schools, Poor Students: Tapping University Endowments to Improve Student Outcomes.” The report explored how average taxpayers are subsidizing the education of students enrolled in the well-endowed and more selective schools to a far greater extent than they are supporting the education of their own children, most of whom are far more likely to be enrolled, if at all, in a state university or a community college than in Harvard, Princeton or Yale.

For example, we estimated that every student at Princeton University was receiving over $100,000 per year in taxpayer support as compared to a student enrolled in nearby Rutgers University, where the per student taxpayer support was approximately $12,500. The numbers for Harvard vs. University of Massachusetts Amherst were $48,000 and $9,900 respectively.

Working with our input, the Senate Finance Committee proposed legislation and Congress passed the Tax Cuts and Jobs Act (TCJA), implementing a tax on the 50 or so richest schools in the nation (those with endowments over $500,000 for each full-time student). However, because of various carveouts, the tax yield has been far smaller than expected: recently yielding only around $68 million, much less than the expected $200 million. Moreover, there is a general lack of transparency about how much the universities subject to the tax pay.

Given that most adherents of the tax have been disappointed in the yield and given the rising anger at elite universities, the issue of taxing the largest university endowments is back on the table. As is to be expected, the higher education lobby will do everything possible to shut down any legislation aimed at raising the tax on endowments.

But a sensible path forward exists: The money raised by an adequate endowment tax could be tied to support a popular reform that can directly benefit low-income students and help meet the nation’s need for skilled workers.

In contrast to the intense fights over taxing endowments, there is bipartisan (and bicameral) support for “Short-Term Pell” grants that would be available to students who are enrolled in programs that offer between 150 and 600 hours of instruction in a high demand field of employment.

Despite the appeal of the program, there is no agreement on how to pay for it. The Congressional Budget Office has estimated the cost of Short-Term Pell at $160 million per year. As noted, while information about the yield of the existing tax is surrounded by a fog of uncertainty, using public information, we have identified 37 institutions with endowments of more than the current cut point of $500,000 per student.

We propose the following approach to establishing the tax base and the tax rate, an approach that matches the way in which private foundations are already taxed:

At the end of fiscal 2022, these 37 super-rich schools held $359 billion in endowments. Endowments fluctuate with the economy, so we propose taking a four-year rolling average of each institution’s endowment. (We suggest this period because the end of Fiscal 2019 was before COVID-19 and the end of Fiscal 2022 year was afterwards.) On average, the endowments of these 37 schools gained $25 billion across the period.

Applying the 1.39 percent tax rate private foundations pay to this $25 billion gain would yield $347 million, more than enough to support Short-Term Pell and to build up a reserve fund to meet these costs if university endowments decline.

Given just how rich these schools are, these tax payments represent, on average, less than 0.04 percent of the endowments held by each of these schools. The yield from this relatively low tax could be put to a better and more urgent use: Training low-income workers to help the nation meet its critical labor shortage.

Mark Schneider was director of the Institute of Education Sciences from 2018 until March of this year. He is Distinguished Professor Emeritus of Political Science at Stony Brook University. Jorge Klor de Alva is president of Nexus Research and Policy Center and former professor of anthropology at Princeton University.