And Then They Came for the Endowments

If you’re anything like me, you’re worried about what the House Ways & Means Committee’s budget reconciliation billwill do to the nonprofit sector. I’ll be blogging about that this week. Today, my focus is on the sweeping changes to the endowment tax and its potential impact on affected universities.

The legislation known as the Tax Cuts and Jobs Act (TCJA) of 2017 enacted a 1.4% excise tax on private universities’ endowments with endowment assets of $500K or more per student. Although its effect was rather modest, this excise tax was unprecedented. Worse, its “cliff effect” meant that, as a proportion of the endowments it taxed, it hurt universities just over the statutory threshold worse than those well beyond it. And worse still, the incidence of this tax was likely passed on to students and their families in the form of hikes in higher education costs at affected institutions.

Now, if you’re a frequent reader of this blog, this all may be familiar to you, because I have blogged about, written scholarship on, and done press interviews about this topic this year alone. But that’s old news, and this proposal is different. The House’s budget reconciliation bill cuts much deeper.

For one, it is tiered but still keeps in place the “cliff effect.” It proposes a 1.4% excise tax for universities with endowments between $500K and $750K per “eligible student”—more on that in a moment. So, no real change there. Yet, its proposed progressive excise tax rates get steeper for universities with endowments between $750K and $1.25M per student (7%), much steeper for universities with endowments between $1.25M and $2M per student (14%) and steeper still for universities with endowments over $2M per student (21%). By my count, and with an assist from Forbes, at least 14 universities will stay in the 1.4% tranche, 14 universities will see their endowment tax liability increase 5x (7%), 10 universities get hit with a 10x endowment tax increase (14%), and 3 universities will see their endowment tax liability increase 15x (21%)—if the bill is enacted as it stands. At the highest rate, this is essentially a corporate tax on nonprofit entities.

Now it’s time to unpack the “eligible student” definition that the bill inserts. It would seem to include US citizens, permanent residents, and those present in the US for non-temporary purposes with the intent to remain. However, it seems to exclude international students on temporary visas or undocumented students. So, universities with large numbers of these latter groups of students could face a disproportionately higher effective tax rate, because it would change the denominator on which the statutory formula is based. Quite likely, it will expand the number of universities subject to the tax—in some form—in total.

It also bears noting that there is a religious exemption put into place in the proposed bill that the TCJA’s endowment tax provisions did not have. That is, religious universities with a continuous church affiliation and mission aligned with religious doctrine are exempt from the proposed tiered tax structure, reflecting a broad carve-out for religious institutions throughout the proposed legislation.

The proposed changes to the endowment tax represent an escalation in the federal scrutiny of higher education. The TCJA’s endowment tax was effective but was largely symbolic, because it only impacted the nation’s wealthiest institutions. Under this new framework, the tax takes on a redistributive—not to mention confiscatory and punitive—character. But the net effect of the new framework for the endowment tax is that it will affect more universities and tax most of those already subject to the tax at inflated rates. And just like tariffs, we know what happens next. The incidence of the tax will likely be passed onto the consumer. That means students and their families will foot the bill.

If one goal of the tax is to lower the rising costs of higher education by encouraging universities to spend more on institutional aid, this does the opposite. But more likely, it’s a tax on elite institutions for being “woke.” The problem is that it strikes at these institutions, but it hits hardest at other schools like McPherson, Berry, Earlham—all institutions that just meet the statutory threshold and can’t really afford the tax without cutting institutional aid. It’s not measured policy; it’s just bad all around.

 

Christopher J. Ryan, Jr.

Indiana University Maurer School of Law