Here’s What Congress’s Endowment-Tax Plan Might Cost Your College

Since the 2017 Tax Cuts and Jobs Act, a few dozen wealthy colleges and universities have paid a tax of 1.4 percent on the net investment returns from their endowments. The low rate meant the tax burdens were small relative to the size of their operating budgets. But recent legislative proposals have those costs set to balloon. How much they will go up, how the tax will be structured, and what incentives they create for institutions remain open questions.

The budget bill that passed through the House Ways and Means Committee this week differs significantly from an earlier Congressional proposal. Under the current law, colleges with endowments exceeding $500,000 per student are subject to a small tax on their investment returns. In January, a draft proposal floated increasing that 1.4 percent tax to 14 percent. That increase served as the basis for projections I made in The Chronicle last month.

The new House bill would replace the flat rate with a tiered system based on “student-adjusted endowment,” defined as endowment assets per domestic student (excluding international students). The new tax brackets are as follows:

• $500,000 to $750,000 in student-adjusted endowment: 1.4 percent tax rate
• $750,000 to $1.25 million: 7 percent
• $1.25 million to $2 million: 14 percent
• $2 million and above: 21 percent

An institution’s endowment-tax fate would now depend both on how its student-adjusted endowment is calculated and where it falls within these new brackets. Because international students are now excluded from the denominator, some institutions are confronting big jumps in tax liability. I’ve estimated what select tax-paying institutions could owe in a typical year based on publicly available data. Of course, greater precision in actual, current data and the realized gains these endowments receive will affect these estimates, which should be interpreted as guides to the impact these institutions will face.

According to my projections, several institutions with large endowments — Harvard, Yale, Stanford, and Princeton Universities and the Massachusetts Institute of Technology — would now face significantly larger tax bills, ranging from $400 million to $850 million per year. (I assume an average rate of return of 7.5 percent.) Other institutions, like Columbia University, would see large tax increases not because of endowment growth, but because of the fine print of the proposed legislation. Previously exempt due to an endowment per student below $500,000, Columbia would now face an $80 million tax — it lands just above the $750,000 threshold and thus qualifies for the 7-percent tax rate. Small liberal-arts institutions like Amherst, Pomona, and Swarthmore Colleges are similarly affected — excluding their international-student populations inflates their adjusted endowments, bumping them into the 21-percent tax bracket.

Conversely, some institutions “benefit” from the new system, compared to the January proposal. Colleges like Carleton, Hamilton, and Middlebury fall into the $500,000-to-$750,000 category and remain there even after international students are excluded. For them, the tax rate drops from the previously proposed 14 percent to 1.4 percent, thanks to the new tiers. Duke University, Emory University, and the University of Pennsylvania, whose adjusted endowments fall between $750,000 and $1,250,000, would also see a lower tax rate — 7 percent instead of 14 percent. Religious institutions are also exempted, which could perhaps affect the University of Notre Dame and Trinity University, in Texas.

The new bill also opens new avenues for tax avoidance. The expanded tier structure creates incentives for institutions to lower their student-adjusted endowments — potentially by reducing international enrollment, increasing the number of students they enroll, or altering spending strategies to remain just below higher tax thresholds. The incentive to reduce the number of international students certainly seems intentional.

Although some institutions may fare better than others under this revised bill relative to the January proposal, there are not “winners” and “losers” here. All institutions subject to the tax stand to lose. The imposition of this tax will reduce educational resources, including financial aid, and institutions that engage in tax-avoidance strategies would have to make choices they otherwise wouldn’t — choices that could compromise future generations. Increasing current endowment spending to reduce its size (and the resulting taxable income) could ultimately hurt students. Domestic students benefit from the perspectives international students bring to the table.

As the budget process continues to unfold, further revisions to the endowment tax and related funding provisions are likely. Higher education should brace itself for more congressional tinkering with our major universities’ financial fortunes. These actions will wreak havoc on institutional budgets, leading to cuts in financial aid and programming that are not in our students’ best interests, let alone those of the nation. But stopping a runaway train is difficult, and that appears to be where we stand.