Facing First Tax on Endowments, Colleges May Be Set to Dodge It

(Bloomberg) -- Private colleges facing a new endowment tax may “behave strategically” to avoid paying it, according to a study published Thursday by a senior researcher at the Federal Reserve Bank of Cleveland.

Schools may increase enrollment -- or give the appearance of doing so by changing the way they measure it -- to reduce their endowment-per-student ratio to miss the tax threshold set by Congress, wrote economist Peter Hinrichs. Those colleges with low enrollment may reduce it in order to stay below 500 students to avoid the tax.

College endowments hold $567 billion in assets as of June 30. The tax would hit about 30 schools with at least 500 tuition-paying students and with assets of $500,000 per student. The list of schools is unclear because the Internal Revenue Service hasn’t yet issued details about how students or endowments will be counted, among other factors.

“Colleges may also find other ways of circumventing the law,” Hinrichs wrote.

Read more about supporters of the endowment tax repeal proposal

Schools are lobbying to repeal the 1.4 percent tax on annual net investments and are helping to encourage sponsors to join a bipartisan bill to ax it.

At least one school, Berea College, is exempt because the law was modified to apply to only schools with 500 tuition-paying students. Berea students don’t pay tuition, as they are all low-income students who hold jobs to defray costs.

Schools that meet the cutoff of $500,000 of endowment per student include Princeton University with a $24 billion fund and Williams College with $2.5 billion.

Other schools expected to pay the tax include large research universities such as Harvard and Yale and small liberal arts colleges including Grinnell and Swarthmore.

Read about Harvard and Yale Working to Repeal Endowment Tax

Hinrichs wrote that some commentators said the tax makes it more difficult for colleges and universities to fulfill their educational missions while others argue the tax gives schools an incentive to spend endowment funds on research and teaching instead of receiving “tax advantages to invest in risky assets.”

The two initial sponsors of the repeal bill, Republican Bradley Byrne of Alabama and Democrat John Delaney of Maryland, said since the December legislation didn’t include adjustments for inflation, it’s likely more institutions will be subject to the tax in the future.

“We’ll probably see more and more colleges swept up in the endowment tax going forward,” Hinrichs said in an interview.

In the report, he noted that the “exact number will depend on implementation details, the overall rate of inflation, changes in real endowment values, and any strategic responses on the part of colleges.”

©2018 Bloomberg L.P.

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