Nonprofit Universities Invest Assets in Offshore Tax Haven Funds—Is This OK?

November 18, 2017; Daily Pennsylvanian

As the Daily Pennsylvanian details, the University of Pennsylvania (“Penn”) is among over 100 universities identified by the “Paradise Papers” as having invested endowment assets in overseas tax havens.

For example, in fiscal year 2015, Penn invested $84,463,005 in one such overseas fund called the PAM 1740 Fund, the moniker “1740” being chosen to reflect the year of the university’s founding. Apparently, the PAM 1740 Fund is one of four “1740” funds wholly owned by Penn that are housed in “the Cayman Islands, a British territory with virtually no taxes.”

According to Samuel Brunson, a law professor at Loyola University Chicago who specializes in tax policy, the investment by the PAM 1740 Fund was made into a “blocker corporation.” As reporter Caroline Simon explains:

Blocker corporations are commonly used by wealthy individuals or organizations looking to skirt American taxes. While Penn’s status as a nonprofit exempts it from taxes that it might otherwise pay on its endowment returns, it is still taxed on income from investments made with borrowed money, including money invested in private equity funds and hedge funds.

Oddly, according to the article, the main criticism of this practice is that it “raises questions of how colleges should be handling their money, especially in an era of climbing tuition prices and mounting student debt. Critics argue the purpose of an endowment is to fund research and learning, not to pursue risky private investments that avoid taxes.” Tuition, room, and board at Penn are estimated to cost $68,610 during the 2017–18 school year.

But is risk of a lower financial return what should concern us here? After all, investment theory says that high risk also brings the possibility of high reward. Now, surely there are some years that Penn has had poor returns. But given that Penn earned a 14.3 percent return last year, raising its endowment value to $12.2 billion, at least from a financial perspective, it would seem that Penn’s team is doing better than OK in the “managing endowment dollars” department.

A more reasonable question to ask, however, is whether or not it is consistent with the missions of Penn and over 100 fellow nonprofit universities to invest in funds that facilitate tax evasion.

Berkeley economist Gabriel Zucman last week estimated that tax shifting by corporations using such funds costs the federal government $70 billion each year, an amount that is equivalent to 20 percent of total corporate income tax that is collected and nearly equal to total food stamp expenditures. This does not include money shielded by private individuals. Worldwide, Zucman writes that, “an estimated $8.7 trillion, 11.5 percent of the entire world’s GDP, is held offshore by ultrawealthy households in a handful of tax shelters, and most of it isn’t being reported to the relevant tax authorities.”

Regarding the common university practice of investing in funds that are housed in offshore tax havens, Brunson, the law professor, says, “There may be bad things about it—I don’t like the fact that we send a lot of money through tax havens—but that’s the way the tax law is written…It’s not morally good or morally bad.”

But maybe, even if funds that facilitate corporate tax evasion are legal, it actually is morally bad for nonprofit universities to act in ways that deprive the public sector of needed resources to address social problems. It’s really not all that hard to see why nonprofits might want to steer clear of such practices. As Penn president Amy Gutmann has noted, “A university is, first and foremost, a social undertaking to create a social good.” Investing assets in funds that facilitate corporate tax evasion is a dubious means to achieve that end.—Steve Dubb