Should huge college endowments pay tax?

With nine of its colleges and universities boasting endowments above $1 billion, Massachusetts is now center stage in the emerging national debate over whether wealthy schools are doing enough to justify their tax-exempt status.

The reason for the spotlight: a first-of-its-kind proposal to tax those large endowments in the Bay State.

It has caught the attention of some members of the US Congress because it goes well beyond discussions there that have so far focused on increasing transparency and pushing well-endowed schools to spend more to offset costs.

"Two things are on a collision course: The public anxiety about the cost and affordability of college is very, very high, while [wealthy institutions] ... are sitting on what appears to be huge pots of money," says Patrick Callan, president of the National Center for Public Policy and Higher Education in San Jose, Calif.

The Massachusetts proposal would impose a 2.5 percent tax on the portion of endowments above $1 billion.

"There is an exorbitant amount of wealth that has been generated with these endowments, especially in the case of Harvard and MIT," about $35 billion and $10 billion, respectively, says state Rep. Paul Kujawski (D), who proposed the tax plan in part because the state is facing a $1.3 billion budget gap. "When is a nonprofit considered not a nonprofit?" he asks.

The precedent it could set worries college officials.

"It's terrible tax policy and it's terrible public policy," says Richard Doherty, president of the Association of Independent Colleges and Universities in Massachusetts. "It to some extent ignores the tremendous contributions to the Massachusetts economy that the private colleges already generate."

The nine schools with endowments over $1 billion employ nearly 27,000 people in Massachusetts, who collectively earn $4.5 billion, Mr. Doherty says. He adds that the state has to spend less of its budget on higher education than other comparable states because of the abundance of private colleges here. Faculty and students also offer voluntary services worth millions of dollars.

Boston College spokesman Jack Dunn says the tax "would hurt the very individuals that the legislators presumably are trying to help: the people in their districts who need financial aid to attend these schools." He characterizes the nearly $1.7 billion endowment as "modest" but says that BC admits students without regard for their ability to pay – and then meets their full need for financial aid. The tax would make that need-blind policy unaffordable, he says.

Another concern is that donations would decline, Doherty says, "because people would understand that their donation could well be subject to a 2.5 percent tax."

"The notion that education is a charitable not-for-profit activity has deep roots in our country," says Matt Hamill, senior vice president of the National Association of College and University Business Officers (NACUBO) in Washington.

Representative Kujawski says he values the contributions of these colleges. But he's heard from donors to places like Harvard and the Massachusetts Institute of Technology who have encouraged him to stand his ground. "They feel that these schools, with the amount of wealth they have, could enhance the areas [in which they reside]," he says.

The Massachusetts House passed an amendment in its recent budget deliberations that would require the Department of Revenue to study the 2.5 percent tax idea. Kujawski says he believes there will be support for the study on the Senate side as well, and that would inform future legislation.

A college could legally challenge such a tax based on a provision in the Massachusetts constitution that prohibits arbitrary distinction between similar taxpayers, Doherty says. But because the distinction is based on asset levels, it wouldn't be arbitrary but legitimate, counters Dean Zerbe, national managing director of alliantgroup, a Houston tax-services firm. He is also a former counsel to the US Senate Finance Committee, which has been investigating college-endowment issues.

The Senate Finance Committee recently requested, for the first time, detailed endowment data from 136 schools that have amassed at least $500 million. Staffers are analyzing the responses before deciding whether to introduce legislation.

One idea gaining ground in congressional discussions would be to require colleges to spend at least 5 percent of their endowments each year, which private foundations already must do.

Lynne Munson favors that idea. She is studying endowments as an adjunct fellow at the Center for College Affordability and Productivity in Washington, and she says that higher-education officials sometimes exaggerate how much endowments are restricted by specific requests from donors. At private colleges, an average of 45 percent of endowment funds are unrestricted, she says.

Aggressive investment has led to high returns on endowments for the past 10 years, Ms. Munson adds. "Colleges and universities have had at least a decade to come up with a strategy for ... putting those monies to work for students, families, and taxpayers, yet they've neglected to do so," she says.

Congress's scrutiny of higher-education costs appears to have already prompted some good news on affordability. Harvard and at least two dozen other schools have created policies in recent months to increase grant aid for students or to cut tuition.

Those moves have pleased Sen. Charles Grassley of Iowa, the ranking Republican on the Finance Committee, says press secretary Jill Gerber, but they "are likely just a drop in the bucket." Hundreds of schools have large endowments, and "even schools with smaller endowments should still look at whether they can do more to help with affordability," she says.

The Massachusetts tax proposal has "changed this debate quite a bit" in Washington, says Mr. Zerbe. "If the universities aren't forthcoming, there will be a rising frustration level," and more members of Congress might think about looking at a tax, he says.

But the relationship between tuition and endowments isn't so clear-cut, says Mr. Hamill of the college business officers association. "There's been a tendency to think of an endowment as like a giant checkbook ... and the reality of managing an endowment is significantly different," he says. "The government is not going to be a good regulator of this issue."