Harvard Faces Endowment Tax
The tax changes enacted yesterday by the Republican majorities in the U.S. House of Representatives and Senate and awaiting signing into law by President Donald Trump impose a tax on a few dozen college and university endowments’ investment income—but they did not incorporate most of the other features that most alarmed the higher-education community (see “Taxing Matters”). Thus, graduate students do not face an onerous cash tax bill for the imputed income associated with their (typically waived) tuition bills, nor do students and families face the loss of the deductions associated with interest on their education loans. Universities and colleges can still resort to the tax-exempt bond market to finance construction projects.
But the issue that most troubled Harvard’s leaders, and those of a couple of dozen other fortunate institutions, has become law: colleges and universities whose endowments exceed $500,000 per student, and that have more than 500 students, are now subject to a 1.4 percent tax on annual investment earnings. The roster of affected schools begins with Princeton and extends through Yale, Harvard, Stanford , and MIT, through colleges such as Pomona, Amherst, Swarthmore, Grinnell, and Williams.
The exact impact awaits university calculations after the final details of the legislation are analyzed. Given the formula, more schools could become subject to the provision as their endowments appreciate or as they enroll more students—and of course, revenue-hungry lawmakers could easily boost the government’s take in the future. In the near term, President Drew Faust estimated that Harvard would have had to pay about $40 million on its investment earnings during the fiscal year ended last June 30 (see here for the calculations). The longer term is less calculable, and perhaps of greater concern: if endowment earnings increase, so will the levy; and revenue-hungry legislators could always increase the tax rate, now that the precedent exists.
Furthermore, the tax law both increased the standard deduction for individuals and families, which may make prospective donors less eager to act philanthropically (since the value of itemizing charitable deductions is diminished), and limited the deduction for state and local tax payments and deductions for interest payments on future large mortgages—both of which raise the costs for many prospective donors.
Now that endowment earnings themselves may be taxed, it is also possible that donors will become more interested in making project-specific, term-limited grants, rather than permanent endowment gifts (see the structure of the recent $12-million grant by Priscilla Chan ’07 to support public-service activities at Phillips Brooks House Association). The new tax is an additional, and highly visible, wrinkle that financially sophisticated donors may consider when deciding how to structure their philanthropic support for elite colleges and universities. That comes just as those institutions are worrying about the ability of their heavily endowment-dependent financial models to support research, teaching, libraries and other academic infrastructure, and financial aid.
A Harvard Gazette article on the tax law quotes Faust as saying:
I am deeply concerned that the adoption of an unprecedented excise tax on charitable organizations that targets certain colleges and universities will weaken our ability to support students and research. The provision will constrain the resources that enable us to provide the financial aid that makes college more affordable and accessible and to undertake the inquiries that yield discoveries, cures, innovation, and economic growth.
We will assess the damaging impacts of this tax legislation moving forward, and we will continue to engage policy makers in substantive conversations on higher education finance to ensure a deeper understanding of the role college and university endowments play in making higher education accessible to students from across the country.