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Editorial

Targeting endowments

Congress, desperate for more revenue to fund a record federal budget and the rising outstanding federal debt, seems to be looking look to a potential new source — private college and university endowment funds.

In a strident letter dated Feb. 8 to presidents at 56 of the colleges and universities with more than $1 billion in endowment assets, the chairmen of three congressional panels put a spotlight on the schools' investment and spending practices, questioning “the numerous tax preferences they enjoy,” including exemption from federal taxes on their investment earnings.

A centerpiece of the inquiry's focus is the investment return and payout rate, in contrast to rising tuition costs “far in excess of inflation.”

The letter turns up a large disparity in performance and tuition fees. It cites a study from the Washington-based National Association of College and University Business Officers that “showed endowments had an average return on investment of 15.5% and an average payout rate of 4.4% during the 2014 fiscal year.”

Congressional leaders want to know whether the tax preferences are being put to good use as defined by them. In other words, the letter suggests a threat to strip them away unless spending meets spending priorities set by congressional intervention. It's a populist impulse in an election year to win favor with students and parents as well as faculty.

But there is a lot wrong with the supposition of the inquiry by Sen. Orrin G. Hatch, chairman, Senate Committee on Finance; Rep. Kevin Brady, chairman, House Committee on Ways and Means; and Rep. Peter J. Roskam, chairman, House Ways and Means oversight subcommittee. For a start, spending rates should not be determined by one year's performance, but by long-term performance.

College and university leaders, as well as the endowment fund leaders, must strongly call out the congressional leaders, making the case for the societal benefits of their investments and enlightening Congress on the purposes those growing assets serve.

As Heather Myers, managing director, non-profits, Russell Investments Inc., Seattle, pointed out in an Oct. 19 Other Views commentary in Pensions & Investments, “The results consistently show it is highly unlikely that a portfolio can grow in perpetuity if required to spend 5% or greater per year.” Unlike endowment funds, “private foundations are required to spend 5% per year, which might potentially put them at risk of depleting their assets.”

Even so, raising the spending rate would have ramifications aside from jeopardizing the sustainability of an endowment fund. A higher spending rate would affect the long-term performance of an endowment fund and its subsequent ability to increase its payout because the fund would need more liquidity to raise cash to spend. This need for added liquidity would compel endowment trustees to lower their allocation to return-seeking assets that are less liquid but produce higher expected returns, such as the double-digit one-year performance number the congressional leaders quote in their letter.

Higher allocations to cash equivalents would greatly reduce the growth rates of the funds, ultimately meaning less money to spend on scholarships and aid to students.

The congressional leaders suggest the double-digit returns they quote are the normal performance trend, but they are far from it.

Yale University, the poster child endowment for superior performance, lost 24.6% in the 2009 fiscal year during the financial market collapse. Endowments tracked by NACUBO lost an average 18.7% that fiscal year.

The 10-year average annual return for the NACUBO-tracked endowment funds was 6.3%, not much higher than the average spending rate of their colleges and universities.

An endowment fund's spending rate may remain relatively the same at 4% or 5% over the years. But as an endowment grows, the absolute dollars from that spending rate will grow, producing more money to spend to enable more students and academic programs to benefit from the investment performance. At those spending rates, for example, an endowment that grows to $7 billion from, say, $4 billion has more absolute dollars to spend on academic programs and students than an endowment that shrinks to $1 billion or less.

Some public pension funds show the risk of raising spending rates. As their assets grew in the heart of the bull market in the 1990s and early 2000s, they felt safe to raise pension benefits to more generous levels, instead of securing a funding cushion. Now, facing unfavorable interest rates and investment markets, they put the sustainability of their funds at greater risk.

Taking away the tax preferences from endowment funds would mean colleges and universities would have to raise tuition for students by at least the amount in taxes they would have to pay and defeat a spending priority of the congressional leaders.

Over time, taxes would eat away an endowment fund, leaving it with little in the way of assets, defeating the purpose of taking away tax preferences.

Requiring them to spend more on subsidizing tuition would reduce the ability to attract and retain faculty talent, finance existing and new academic programs as well as campus infrastructure including technology.

Private colleges and universities compete with public schools for students and faculty members. They take some of the financial pressure off the states in their support of the public institutions. Otherwise public spending on higher education would even be greater as they would have to absorb many more students.

Interestingly, no public colleges and universities, some of whose endowment funds are much larger than many of the private higher educational institutions, were called to the carpet by the congressional leaders.

As for excess tuition, some suggest Congress should take part of the blame. Paul F. Campos, a law professor at the University of Colorado Law School, Boulder, wrote last year saying, “the astonishing rise in college tuition correlates closely with a huge increase in public subsidies for higher education.”

Congress ought to scrutinize itself with its budgetary spending far in excess of inflation and far removed from a relationship with tax revenues, causing an overreliance on debt to finance the budget.

Private schools have to keep their budgets within their financial means. Unlike Congress, they have no debt ceiling they can keep raising.

Congressional leaders ought to focus on reviving the economy, boosting corporate profits and individual incomes, which will provide many times more new tax revenue than the relative chump change to be found from taxing endowment funds.

If the investment return of endowments of private colleges and universities were taxed at the 35% level, the revenue gain would be an estimated $11.1 billion for fiscal year 2014, according to a Dec. 2 report from the Congressional Research Service, which provides analysis exclusively for Congress.

But Congress has not been known for its sound fiscal management. Private colleges and universities have to be, otherwise they risk their sustainability. n

This article originally appeared in the February 22, 2016 print issue as, "Targeting endowments".