College Endowments and Controversy

By Sandy Baum, PhD    //    Volume 27,  Number 3   //    May/June 2019

With endowments and their tax status in the spotlight, trustees must understand how they are distributed across colleges and universities and how institutional wealth is related to student body demographics and student aid practices—whether their institutions have significant endowment assets or not. To respond constructively to criticisms of higher education and the way institutions use their resources, trustees should understand the arguments from all sides about the role of endowments and the federal government’s interest in that role.

College endowments were in the news when Congress included a tax on the income from the investments of a small number of private nonprofit colleges and universities in the Tax Cuts and Jobs Act of 2017. The outsized attention generated by the recent revelations about a small number of wealthy parents taking startling illegal and unethical actions to gain admission to particular elite colleges for their children has likely generated renewed energy for imposing new penalties and restrictions on highly selective educational institutions, which tend to have large endowments.

Like other private nonprofit and public entities, educational institutions build and maintain endowments to supplement other revenues in supporting current expenditures and to protect against temporary declines in revenues, disruptions in financial markets, and unanticipated major expenses. Endowments ensure that institutions can maintain their operations in the long run, enabling them to subsidize the education of successive generations of students. If they were to spend down their endowments, these supplementary revenues would no longer be available. Endowments can also help finance the expansion of an institution’s mission, especially at large universities.

Colleges and universities use their endowments to support a wide range of activities with social benefits. In addition to educating undergraduates from diverse socioeconomic backgrounds, many institutions subsidize research, public service, and graduate students—activities that are central to the charitable mission of higher education.


How large is your institution’s endowment? Consider both the dollar value of the endowment and the value per student.
How much does the draw from the endowment add to the annual budget?

A few colleges and universities have large endowments, but most have small endowments that do not contribute substantially to their annual revenues. At the end of academic year 2015–16, US colleges and universities held endowment assets totaling more than $530 billion. About 40 per-cent of these assets belonged to 20 private nonprofit research universities, and 20 percent of the total belonged to just four institutions.

Ten institutions (out of 3,300 public and private nonprofit colleges and universities), including three public university systems, had endowments exceeding $10 billion, and 100 had endowments greater than $1 billion. In other words, endowment assets are unequally distributed across higher education institutions. The endowments of the wealthiest public research universities, enrolling 10 per-cent of students in the sector, average about $137,000 per full-time equivalent student. Those in the lower half of the distribution ranked by endowment per student—where 50 percent of this sector’s students are enrolled—average less than $10,000 per student. The distribution is similarly skewed within each segment of private nonprofit institutions—although the scale is very different in these research and bachelor’s institutions. The average endowment per student at the wealthiest private nonprofit research universities enrolling 10 percent of students is about 10 times the assets at the wealthiest private research universities—and three times the assets at the second decile of universities.

Endowment assets, therefore, are tightly concentrated at a small number of institutions. Federal involvement in how these assets are used or in whether or not they are taxed is irrelevant to the circumstances of most colleges and universities.


How large is the endowment per student at our institution?
How do these assets compare to similar institutions? To other institutions within the sector?

In both the public and private nonprofit sectors, colleges and universities with large endowments per student enroll fewer low-income students than institutions with lower asset levels. This under-representation of low-income students at relatively wealthy institutions is a major factor in criticisms of how institutions use their endowment assets. Both politicians skeptical of educational institutions and advocates for the role of higher education in reducing inequality and supporting social mobility argue that institutions with ample resources should be using those resources to educate more students who are not able to finance their own education.

A more complete view of the way high-endowment institutions serve low-income students includes information about how the relatively small share of high-need students who do enroll at the highly selective, highest-endowment institutions finance their education. The data reveal that the wealthiest institutions use some of their resources to provide generous need-based financial aid, charging low-income students much lower net prices than their more affluent classmates—and lower net prices than similar students pay at less well-resourced institutions. This pattern appears in both the public four-year and private nonprofit four-year sectors, although it is most pronounced at the well-endowed private institutions. Students with incomes below $48,000 paid an average net price of less than $7,000 at these colleges and universities in 2015-16, compared with more than $20,000 at other institutions in the sector. Students from families with incomes exceeding $110,000 paid an average net price of over $40,000 at these high-endowment institutions.


What share of undergraduate students at our institution receives federal Pell grants, which fund low- and moderate-income domestic students? How much of the financial aid at our institution is need-based, as opposed to being allocated on the basis of academic preparation, athletics, or other student characteristics? How do the net prices paid by students with different incomes compare at our institution?

The tax exemption on endowment income is a subsidy in the form of a tax expenditure, affecting the federal budget the same way direct payments to these institutions would. Colleges and universities with large endowments would have large tax bills in the alternative universe where charitable organizations paid taxes on their investment income. The federal treasury is sacrificing that income in the interest of subsidizing charitable activity. But it provides little subsidy to institutions with minimal endowments.

This distribution of subsidies across institutions raises questions regard-
less of the extent of the social benefits colleges and universities generate. But understanding those social benefits, which extend far beyond the provision of opportunities to low-income students, is critical to evaluating the tax exemption on endowment income.

Colleges and universities educate graduate students, produce and disseminate research, promote intellectual inquiry and cultural engagement, and contribute to their communities in a variety of ways. Their educational mission defines colleges and universities as charitable organizations; improving the circumstances of the less privileged members of society contributes to, but does not determine, this status.

Because of the long-standing tax exemption on income from the endowments of charitable organizations, it is not surprising that higher education administrators view the idea of any tax on this income as a penalty and an abrogation of important principles. Singling out colleges and universities—as opposed to other non-profits—contradicts the established definition of charitable organizations, which is clear about the centrality of education.

But some observers contend that current students are poorly served by underspending from endowments and that the federal government should not encourage the directing of resources away from the provision of educational opportunities for current students. In particular, if institutions cut their budgets in economic downturns in order to protect their endowments, they may not be allowing these funds to serve their intended purpose. The social benefits of increasing educational attainment are high and the return to need-based aid and expanded enrollment and success among underserved students has the potential to accelerate growth and the options for future financing.

As noted above, endowment income supports subsidies to all students, allowing colleges to charge prices that do not cover the full cost of education. Comparisons across types of institutions within the private nonprofit four-year sector shed light on the relationship between endowment levels and the subsidies benefiting students. In 2015–16, on average at private research universities, where endowments averaged $206,000 per student
(with a median of $55,000), net tuition and fee revenue covered only 54 percent of education and related expenditures, with students receiving a subsidy covering the remaining 46 percent. In contrast, at private master’s universities, where endowments averaged only $21,000 per student (with a median of $14,000), tuition and fees covered 84 percent of education and related expenditures, and students received a subsidy covering only 14 per-cent of the total.


How much subsidy do students paying the full tuition price receive at our institution? When the economy is weak and institutional revenues decline, how does our institution balance relying on the endowment to help maintain spending to support current students with cutting spending to maintain the value of the endowment for the future?

In 2017, Congress imposed a tax of 1.4 per-cent on the investment income of colleges and universities enrolling at least 500 students whose endowments are greater than $500,000 per student. Numerous other proposals from a range of senators and representatives would tax endowments or the income they generate or limit access to federal student aid for well-endowed institutions that do not spend a specified amount on need-based financial aid, keep tuition prices in check, or enroll at least a certain number of Pell Grant recipients. Scholars and college access advocates on both the left and the right have floated similar proposals.

The imposition of taxes on selective educational institutions appears to be at least partially politically motivated, arising out of partisan anger at colleges and universities. But some supporters of these policies are trying to design incentives to change institutional behaviors, generating lower tuition prices, more generous financial aid, or more socioeconomic diversity on campuses. Others argue that the public subsidies represented by the tax exemption should be redirected to have a greater impact on social welfare.

The data revealing the concentration of endowment assets at a small number of institutions and understanding of the federal subsidy these colleges and universities are receiving, combined with the national interest in college access and affordability, makes it reasonable for these questions to resonate outside these campuses. But the very small share of undergraduate students who enroll in highly selective institutions makes a focus on these endowments unlikely to significantly alter educational outcomes in the US.


Will our institution be subject to the new tax? What would have to change in terms of our endowment, our enrollment, or the provisions of the tax in order for it to affect our institution?

Most high-endowment institutions that offer unique educational opportunities and award credentials that are well-rewarded in the labor market could and should enroll a larger number of highly-qualified low-income students. But overall, only 5 percent of undergraduates attend institutions that accept fewer than a quarter of their applicants, so a tiny fraction of students seeking a quality college education would benefit from this change. Changes in pricing and aid policies of the few wealthiest institutions in the nation are less likely to make a dent in the gaps in educational opportunity facing students from disadvantaged backgrounds. For students with the most limited financial resources, the net price of attendance is frequently lower at these institutions than even at community colleges. Moreover, with few exceptions, the students who attend these institutions do very well after college, regardless of their socioeconomic background, so providing this select group with more support is not likely to significantly reduce inequality or increase social mobility.

Colleges and universities have broader missions than just educating undergraduate students. Many also educate graduate students, conduct research, and engage in other public service activities. This means that subsidizing the education of low-income undergraduates represents only a fraction of the social benefits these institutions generate. Colleges and universities with significant financial resources could certainly do more to address inequality in the United States, but taxing them is unlikely to be the most constructive way to accomplish this important social goal.

Perhaps the most compelling argument for modifying public subsidies to colleges and universities through the tax system is that taxpayers are providing large subsidies to wealthy institutions that predominantly educate students from affluent backgrounds and almost exclusively students with strong academic backgrounds who are likely to end up doing very well financially. The tax system does not provide the same subsidies to students at the less well-endowed private nonprofit and public institutions, which educate most students from less privileged backgrounds, many of whom will struggle even to complete college. Colleges and universities should think carefully about how this argument fits with the wide range of social benefits colleges and universities provide.

As with many other issues, the discussion of college endowments is too often based on extremes. Either nonprofit post-secondary institutions bestow large social benefits and any effort to tax them diminishes their capacity to generate these benefits, or wealthy colleges and universities are gouging students, accumulating inordinate wealth, and exacerbating inequality in the United States. A more nuanced approach would recognize the complexity of the issues and provide stronger grounding for engaging in a more productive discussion of public policy and its impact.

AUTHOR: Sandy Baum, PhD, is a nonresident fellow at the Urban Institute. This article is based on a larger project on endowments funded by the TIAA Institute through a grant to AGB.

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