Is the Endowment Tax a Trojan Horse?

New 1.4% tax on private colleges’ investment income could be a ‘harbinger’ for non-profit entities.

Buried on page 289 of the 479-page tax bill passed by the US Senate in the wee hours Saturday morning is a relatively small 1.4% excise tax on the net investment income of certain private colleges and universities.

The tax doesn’t affect many intuitions of higher learning, and it’s expected to add only $250 million to $300 million a year to the government’s coffers over the next 10 years— a drop in the bucket considering the Joint Committee on Taxation estimated the plan would result in almost $1.5 trillion in lost federal revenue during that time.

Nevertheless, this little wrinkle in the tax bill could be an ominous sign, not just for the colleges and universities it affects, but for other schools, foundations, and non-profit organizations.

“I think it’s a harbinger of things to come, I think this is a Trojan Horse,” said Charles Skorina in an interview with CIO. Skorina is the founder of San Francisco-based Charles Skorina & Co., which recruits CIOs and asset managers for endowments, foundations, and institutional investment firms. “Congress has wanted to tax non-profit entities, and I think this is the foot in the door. Some in Congress have regularly railed against tax-exempt organizations.”

Skorina sees the endowment tax as a chink in the armor that protects foundations and non-profits with tax-exempt status.

“If you can tax endowments, then you can start taxing hospitals and religious organizations,” he said. “I believe it’s the beginning of a long-term attempt to increase tax revenue by eliminating the tax-exempt status of non-profit entities.”

Skorina likened the endowment tax to the Social Security’s Supplemental Security Income and Supplemental Security Disability Income programs. He said both of those programs started out as “tiny little harmless items” that supported a few severely handicapped children.

“It started small and no one noticed, and now it’s a huge monstrous program,” said Skorina. “And I think this is the same thing. It’s one of these beautiful Congressional sneak attacks. It’s so small in the beginning that most people don’t see the implications.”

According to the Senate’s version of the bill, the 1.4% endowment tax only applies to private colleges and universities that have at least 500 tuition-paying students, and whose endowment assets have a fair market value of at least $500,000 per student. In the House of Representatives’ version of the bill, the market value threshold was only $250,000, and would have affected an estimated 70 colleges and universities. With that figure doubled, it will mean even fewer institutions will be affected by the tax.

However, it still includes the Ivy League schools, such as Harvard, Yale, and Princeton, which happen to be political soft targets, said Lendell Porterfield, CEO of Washington, D.C., lobbying firm Porterfield, Fettig & Sears.

“Is there a lot of sympathy for Harvard, who has a $36 billion endowment?” said Porterfield in an interview with CIO. “I don’t think Main Street voters care a whole lot about that.”

Porterfield, however, doesn’t share Skorina’s view that the endowment tax is a sign that Congress will go after other non-profit entities. “I don’t think it’s a slippery slope,” he said.

“There’s been some interest on Capitol Hill for years, and I’m not convinced that those private institutions did a great job conveying why they have so much money, or how it’s helping lighten the load or how it’s helping average families.”

Porterfield pointed out that 10 years ago, Sen. Charles Grassley (R-IA) held oversight hearings, and raised the idea of a 5% spending rate for colleges and universities on their investment income. Looking to assuage Grassley’s concerns, and to avoid legislation to enforce his idea, several colleges implemented policies to spend more of their investment on financial aid, and alleviate some of the tuition costs.

However, after additional Congressional hearings on the subject in recent years, “there was an opportunity for these institutions to come up with plans and ideas on how to use the money more effectively, and to convey that plan and communicate it to policymakers in D.C.,” said Porterfield.  “For whatever reason, that message hasn’t been successful, and right now they’re in the tax bill.”

Although Porterfield doesn’t believe the endowment tax means Congress has other non-profits in its sights, he did say there’s nothing to stop Congress from increasing the size of the tax, or lowering the market value per student threshold in the future. 

“Once the dam breaks, who’s to say that next time around they won’t raise it to 2% or 3%,” said Porterfield. “Once you’ve broken the seal on this issue, it can always be raised.”

Which is one of Skorina’s biggest concerns about the tax.

“That’s why I think it’s so sneaky. It’s symbolic. If you think about it, it will only raise a few billion dollars, but it’s harder to defend,” Skorina said, explaining that it is easier to get a small tax introduced, and increase it in later years, than to introduce a big tax from the start.

Despite strong lobbying efforts in the past against any legislation that would tax endowments or dictate how universities spend their investment income, many of the colleges that would be hit by the new excise tax have been relatively quiet in their opposition. For example Harvard, which by some estimates would have to pay $43 million a year to cover the tax, declined to be interviewed for this article.

“There doesn’t seem to be much push back from the colleges,” said Skorina. “It is strange. They don’t want to talk about it.”

Although many of the affected colleges were silent, Nicholas Zeppos, chancellor at Vanderbilt University, which would lose an estimated $7 million a year, was not.

“For Vanderbilt, the proposed bill’s significant and profound impacts on our students, families, and workforce would fundamentally threaten our ability to carry out our mission,” said Zeppos in a statement, adding that the $7 million tab is the equivalent of supporting 104 Vanderbilt students on full cost-of-attendance scholarships. “It is a damaging provision that would tax donor funds, make college more expensive, and reduce support for academic programs and research.”

Tracy Filosa, managing director at Cambridge Associates, who works with universities and nonprofits to align their endowment portfolios with their overall missions, agrees with Zeppos that the endowment tax will hurt the universities it applies to.

“An enactment of these tax proposals in their current form would reduce the amount of endowment proceeds that the affected schools would have available to put toward their missions,” Filosa told CIO. “And affected institutions will likely face the difficult choice of (a) spending less going forward on their mission-based programs, such as scholarships or research, in order to preserve the perpetual nature of the endowment, or (b) continuing to fund programs at current levels, increasing the risk that the value and longevity of the underlying assets would be eroded over time.”  

Filosa added that colleges and universities should continue to monitor the tax legislation situation closely. “Many schools will have to take steps—including some likely painful ones—to adjust,” she said.

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