The Endowment Tax Likely Won’t Do What it Claims to Do | Sanuber on WordPress.com

The 2018 tax law includes an unprecedented 1.4 percent tax on net investment income to schools that have 500 or more students and net assets of at least $500,000 per student. For universities, this applies to their endowments.

Republican lawmakers say the tax mirrors a tax on private foundations and that the goal is to encourage colleges to use their large endowments to lower the cost of education. While the goal seems to be to incentivize colleges to spend their endowment income below the $500,000 per student tax threshold, critics of the law point out that the tax threshold overwhelmingly targets smaller institutions.

For example, in 2016 Columbia received about $10.4 billion in endowments. The university has about 32,000 students, making its 2016 endowment-per-student about $326,000 per student.

Compare this to Claremont McKenna College, which in 2016 had an endowment of $784 million. It only has a student body of 1,347 students. Because of its small population, it’s endowment-per-student is higher than Columbia, about $582,034. It would have to pay about $8000 in taxes while Columbia is exempt.

The obvious answer is to increase enrollment, but there are factors that may limit a university’s ability to do this, such as housing and building capacity. Also, student-to-teacher ratios would suffer and university budgets would be strained.

While the tax doesn’t apply to institutions with student populations under 500, this still penalizes these institutions for growing past 500 students further limiting their ability to invest in capital that would allow them to better accommodate a growing student population. For tuition-free colleges, this makes it even more difficult to stay tuition-free.

Regardless, all universities will now be incentivized minimize their annual investment income to minimize their tax bill. This means treating gains and losses more like private foundations than tax-exempt institutions.

Originally published at sanuber.com on January 20, 2018.