Shocking Endowments

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Like Captain Renault’s encounter with gambling at Rick’s American Café, “I’m shocked, shocked to find that gambling is going on in here,” a flabbergasted U.S. Congress has revealed to the American public that nonprofit universities and hospitals sit on tax exempt endowments amounting to billions of dollars. Not a heck of a lot actually gets spent, in percentage terms less than private foundations that are, by law required to spend—in what the law refers to as “qualified distributions” known in common parlance as private foundation “payout”—while universities in particular continually hammer alumni and the public for donations.

Thanks to the inquiries of Senators Max Baucus and Charles Grassley at the Senate Finance Committee, plus studies they called for from the Government Accountability Office, the word is getting out. But for insiders like Captain Renault pocketing his winnings from the croupier, it isn’t news that many universities sit on mammoth endowments and routinely spend less than the foundations’ five percent, but like much of the sector, they remain submerged in a kind of nonprofit omerta.

Many years ago, I debated a senior official from the foundations’ national trade association and a senior officer of one of the nation’s nonprofit foundations on the issue of foundation payout, around the time when the House of Representatives was considering legislation introduced by Democrat Harold Ford and Republican Roy Blunt that would have removed foundations’ administrative expenses from qualified distributions, making payout basically all grants (plus program related investments).

No names and places are noted here, because the trade association representative told the university hosting the debate afterwards that he would not approve the release a public transcript of the proceedings. I don’t recall exactly what might have been the reason—it certainly wasn’t that I turned into Spencer Tracy in “Inherit the Wind”—but I think one contributing factor might have been an admission by one of my interlocutors that a more fair position would have been, not to raise foundations’ payout, but to establish a mandatory payout for the mandate-less endowments of nonprofit universities and hospitals.

The Senate Finance Committee’s bipartisan leadership has recently turned to examining the endowments and payouts of nonprofit educational and health behemoths, particularly the universities. Part of the obvious calculus is that if foundations were to pay out a bit more from their endowments, the result might be more educational opportunities for kids who can’t meet the astronomical costs of private university tuitions and expenses.

Lo and behold, with a little attention from the two senators, universities are discovering some ways to mobilize some of their tax exempt resources with the result of tuition benefits for some otherwise needy students. News flashes:

In January, Yale announced it would increase its spending from its $22.5 billion endowment by 38 percent, part of which will be used for expanded student aid (and part for expansion of other university functions), having discovered (with the senators’ help) that the university’s spending rate had fallen to a measly 3.7 percent (notwithstanding Yale’s continuing incessant fundraising on top of its accumulated wealth).

The nation’s third wealthiest university (as measured by their staggering endowments), Stanford last summer bumped up its targeted spending rate to 5.5 percent, seeing the impending scrutiny it would get when it announced a 22 percent increase in its endowment in 2007 on top of a payout rate that appears to have hovered in the past year around 4.3 percent (spending of $609 million from an endowment that started the year north of $14 billion in 2007).

The leader of the endowment pack with a $35 billion endowment, Harvard announced a plan to increase its endowment spending including $22 million a year extra on financial aid so that students from families earning up to $180,000 a year would have to spend no more than 10 percent of their household incomes on tuition and fees, essentially providing grant subsidies to write down tuitions for lower income and middle income families.

Isn’t it amazing what queries from a couple of high-placed public officials will achieve?

Of course, like the foundations, the universities and their ideological allies have begun generating their expected counterattacks. Trotting out the admonition against thinking “one size fits all”, Dennis Young of the National Center for Nonprofit Enterprise warns that the Harvards of the world have to think of their larger, multifaceted missions that might be comprised by going the route of “fully endowed” institutions like Cooper Union in New York City or the Cleveland Museum to lower or eliminate costs for its users:

Could Harvard accomplish more in research, advanced scholarship, or community

programming, for example, if students paid something and part of what would have been used for full tuition endowment were invested in new laboratories, libraries, professorships or service programs? Suppose that such investments were likely to lead more quickly to a cure for cancer or cheaper sources of energy? And, would students better appreciate their education, and better invest their time in its pursuit, if they had to pay something for it?”

University trade association lobbyists trotted out the old foundation argument that it’s tough to predict returns on endowments, so that a high mandatory payout, like the nose-bleeding 5 percent required of private foundations, might work during times of high returns, but threaten institutional perpetuity when the market is not so robust.

Speaking for the Congressional Research Service, the indomitable Jane Gravelle (long reviled by some foundations for her 2005 commentary on the spending and returns of donor advised fundsi and in 2003 on private foundationsii) countered with some numbers that make the universities’ low spending rates hard to swallow:

Educational institutions have significant endowments, totaling at least $340 billion in 2006; these endowments have been growing rapidly, and earn a relatively high rate of return. Their overall return of 15.3% in 2006 translates to earnings of $52 billion, earnings that are generally tax exempt. Forgone revenue from not taxing that income at a 35% rate is larger than the total tax expenditure for charitable giving to education.

That last line of Gravelle’s is a kicker, do read it again.

Yet another line of counterattack is the “we’re not Harvard” response, the university counterpart of the “don’t lump us with Ford or Gates” in the realm of institutional philanthropy. One lobbyist’s defense was that unlike the giant profit-sucking sounds of Stanford and Princeton, the two that always seem to raise money the fastest, “most colleges are much more hand-to-mouth.” Others have decried Harvard’s and Yale’s endowment-funded tuition assistance plans as a manifestation of the “deep divide in American higher education”, the few “elite” universities with endowment hoards enabling this sudden surge of tuition noblesse oblige versus the many whose smaller endowments could not be similarly tapped without violating prudent investment standards. Two Columbia University officials opined in the New York Times recently that policies like Harvard’s and Yale’s expanding the pool of students to be aided by virtue of increased endowment spending were “a step backward” that for other universities would mean taking helping wealthier students by taking support “away from relatively poorer ones.”

This issue is not going to go away any faster for universities than foundations. On January 24th, Baucus and Grassley issued a request [pdf] for additional information on universities’ endowment management and spending plans, apparently less than overwhelmed with the completeness of the responses they have gotten so far.

The senators might also return to the issue of top universities’ use of their tax exempt resources for “legacy” admissions, using tax exempt resources to favor students from the families of wealthy donors, an issue brought to the public’s attention in Daniel Golden’s brilliant expose 2006 expose, The Price of Admission: How America’s Ruling Class Buys Its Way into Elite Colleges—and Who Gets Left Outside the Gates, with details about the scions of the privileged at Harvard, Brown, and Duke, among others.

Like many issues roiling the nonprofit sector, the debate over university endowment payout rates echoes past controversies, in this case, the still unresolved clash over the level and composition of private foundation payouts. Tidal waves of university lobbyists will make the furious foundation lobbying against payout look like pond ripples. Are senators Baucus and Grassley simply wasting their time by questioning what goes on with the billions sitting in the tax exempt endowments of nonprofit universities and hospitals—trillions if they decide to reexamine foundation and other endowments?

It’s like Victor Laszlo’s answer when Rick Blaine asked him whether his quest for justice was worth it: “You might as well question why we breathe. If we stop breathing, we’ll die.” For Baucus and Grassley, it is their moral obligation to ask again and again whether the billions American taxpayers have foregone for the tax exempt endowments of private universities are generating the public benefit and social equity they should.