Adam J. Kindschy
| Dec 6, 2017
Adam J. Kindschy is a doctoral student in the Department of Educational Leadership and Policy Analysis at the University of Wisconsin–Madison. He also works as a strategic partnerships specialist in the Office of University Relations at UW-Madison.
Higher education institutions in the U.S. are typically funded by some combination of the following revenue sources: state appropriations (at public institutions), tuition/financial aid, research grants, auxiliary services, and philanthropy.
The focus of this primer will be on the philanthropy revenue source, and more specifically, the university endowment.
What follows should not be considered a comprehensive analysis of the university endowment in U.S. higher education, nor is it a detailed policy brief highlighting all of the reform proposals that have been considered over the years. Instead, this primer seeks to offer some baseline exposure to the university endowment and contemporary reform proposals.
What is the university endowment and how does it work?
The university endowment is not funded with state appropriations, tuition/financial aid, research grants, or auxiliary services. Instead, it is funded through philanthropic gifts and the subsequent investment return on those gifts. The total balance of the university endowment is the sum of hundreds, or sometimes thousands, of different endowed funds. For example, the total balance of the Harvard University endowment is over $35 billion; at last count, approximately 13,000 different endowed funds make up this total balance.
Generally, the university endowment’s purpose is to provide a consistent stream of funding for each endowed fund’s intended purpose in perpetuity, or with no end date.
A (Fictional) Example: Aldo Leopold Graduate Student Fellowship
A generous donor made a $100,000 philanthropic gift to establish an endowed fund at Fictional University. The donor decided to name the endowed fund the Aldo Leopold Graduate Student Fellowship, and its purpose is to support graduate students studying rural sustainability. After the gift is made, Fictional University’s investment team will invest the $100,000 gift. Fictional University has an endowment spending policy of 4.5 percent, so every year, approximately $4,500 of the fund’s earnings would be available to support the Leopold Fellowship.
What if the endowment’s earnings are above or below the endowment spending policy?
Any earnings above 4.5 percent would typically be reinvested back into the principal balance of the Leopold Fellowship. Over time, this means the Leopold Fellowship will grow to have a larger principal balance and provide more support for the fund’s purpose.
Endowments sometimes experience investment losses, and when that occurs, money is simply not available to support the fund’s purpose. Or, in some cases, universities will spend from the principal balance of the fund in an effort to keep funding active.
University Endowment Contemporary Reform Proposals
Higher education institutions nationwide, including public, private, two-year, for-profit, etc., are all subject to varying public policy influence. Since 2008, a small number of federal policymakers have been calling for reform and/or increased federal regulation of university endowments. To date, although no major regulations have been enacted, the chorus of reformer voices remains active. Below are two broad endowment reform proposal themes related to endowment spending, and lastly, new information about a very recent endowment reform proposal that has been included in the U.S. House and Senate versions of the Tax Cuts and Jobs Act.
Theme #1: The federal government should require universities with large endowments to spend more of their annual earnings.
The basis for this type of proposal is rooted in the belief that university endowments boast substantial earnings on an annual basis; as a result, some reformers believe universities should be required to spend a legislated percentage of their annual earnings. Currently, a university’s endowment spending policy is established by the university or affiliated foundation governing board, not the federal government.
Higher education stakeholders speaking against this proposal claim that each institution is different, and the federal government should not legislate spending requirements when so much variation exists. They also note that most universities are already spending a significant percentage of their annual endowment earnings. According to the National Association of College and University Business Officers (NACUBO), the gap between what large endowments are earning and spending is not as big as some people might think. NACUBO data tells us that average annual endowment investment returns for endowments over $1 billion are slightly below 6 percent. The same data also says that in 2016, universities with endowments over $1 billion had an average spending policy of 4.4 percent.
Theme #2: The federal government should require universities with large endowments to spend more of their annual earnings on financial aid.
Some endowment reform supporters believe universities are hoarding money in their endowments while tuition continues to rise; in the reformer’s mind, this contributes to student debt and decreased access to higher education. As a result, reformers believe universities should be required to spend more of their endowment earnings on financial aid.
In response to this proposal, higher education advocates often highlight the widespread misunderstanding that all endowment earnings can be used for any purpose at any time. As mentioned earlier, most endowments are restricted by donors, and universities are legally required to use endowments for the purpose outlined by their donors. Donors often designate their endowments to support specific items, such as scholarships, fellowships, research, equipment, graduate student travel, and faculty excellence. To be sure, there are some unrestricted endowments that offer flexibility, but unrestricted endowments are not nearly as common as those with restrictions.
The U.S. House and Senate have both recently included a university endowment reform provision in their respective versions of the Tax Cuts and Jobs Act.
Currently, university endowments at public and private institutions do not pay income tax on investment earnings. This would change under the House and Senate proposals, which call for the implementation of a 1.4 percent excise tax on private university endowment earnings. The tax would only be implemented at private universities that enroll at least 500 full-time students and maintain applicable endowment assets exceeding $250,000 per full-time student.
It appears this provision seeks to treat private university endowments in the same taxable manner as non-university private foundations. Non-university private foundations are already subject to an excise tax, and the Tax Cuts and Jobs Act would set that tax at 1.4 percent as well.
It is unclear if this endowment reform proposal will stay in the House and Senate bills, but even if this proposal is removed, we can still learn a lot about lawmaker intent by looking at the original proposals. The fact that university endowments are mentioned at all in the original bills calls into question how some current lawmakers view higher education institutions with large endowments. Regardless of what happens with this proposal, endowment reform is likely an issue that will continue to garner the attention of lawmakers going forward.
As the dialogue surrounding higher education endowments continues to evolve, my hope is that this primer has added some baseline information and context to this often-misunderstood topic. Reasonable minds can debate university endowment reform proposals in an effort to maximize support for students, families, and higher education excellence in the U.S. However, any talk of reform must be undertaken with a clear understanding of the facts associated with this multi-dimensional issue.
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