26 USC 501(c)(3) explicitly lists an organization operated exclusively for educational purposes as being tax exempt. Charitable organization is listed as a separate type.
Also worth considering is the example of Cooper Union: It charged no tuition and therefore offered no financial aid for most of its history. While one could argue that that is a form of aid so too would any other tuition reduction enabled by an endowment. This further suggests that universities do not set tuition in order to maintain tax exempt status.
He's not really saying that there is some "50%" magic number in tax law. What he is saying is that, imagine a situation where the price of admission was much more reasonable (i.e. hadn't gone up 300+% in the last generation) so that only, say, 10% of students needed aid. This means 90% of students would be paying full price. Well, if 90% are paying full price, he imagines the political pressure would come to say "Why the fuck are these absolutely gigantic, small country-sized endowments able to earn all this profit, and compound it, tax-free, and still 90% of students are paying full price!"
Thus, he argues that the large universities play this fuzzy-math shell game to consistently jack up the price of tuition so that the majority of students require aid. That way they can argue their endowment profits should remain tax-free because they are going to subsidize the students' education.
That's just my summary, but all-in-all I think the whole essay is powerfully argued. In my mind (and I say this as an Ivy league grad) I agree that getting an Ivy league degree 25 years ago is basically like buying real estate in SF 25 years ago. The overall supply has remained artificially constrained which has made prices go through the roof, with the social signalling and economic benefits accruing to those who graduated when admission rates were higher and tuition was lower.
I’m skeptical both that: Lower tuition would make taxing endowments more likely and that universities believe that that’s the case.
In a world with lower tuition, endowments grow somewhat more slowly and are easier to justify because they are the thing that enables low tuition.
For a more direct set of examples of how much inertia we have, consider the way wealthy individuals use foundations to avoid taxes. I haven’t heard people crying out to tax the Gates Foundation despite its endowment growing over time because it can’t keep up with its contributions. Nor is there a massive uproar about donor advised funds which (particularly in CA) can be 80%+ taxpayer funded while effectively lacking minimum disbursement requirements as part of a larger organization.
Yes, if the tuition were reduced by increased endowment subsidy, the political cover for the endowment would not be much affected.
But that strategy would limit the value of that cover (for the university staff) by 1) ultimately limiting the size of the "politically justified" endowment and 2) limiting the overall resources they control.
Re: 1), if the university contains cost inflation below endowment retained returns, the endowment eventually grows to fund 100% of tuition. At that point, the question "why do they need more?" becomes obvious and unanswerable.
Re: 2), note that the article implies an "agency" effect with university personnel, in that they benefit by their control of the institution's resources. In companies, such effects are seen in executives taking higher than market salaries and excess perks. All that diverts income from equity owners to managers. In a university these might be above-market salaries, research budgets, job security, prestige, trips, subsidized housing, etc etc etc -- diversions of endowment returns from "teaching" to the staff.
The agency model argues that university staff benefit from _growing_ costs, which give them more resources to control. The story that education costs rise faster than inflation and middle class incomes removes the limit on the size of the cost base / resources controlled. It also "politically justifies" an ever-growing endowment.
Thus lowering tuition simply by paying ever increasing portions of tuition does not serve the university staff. The point of the article, I believe, is that those staff have an ongoing interest in _increasing_ the costs to be subsidized by the tax-free growth of their endowments.
(It is also worth noting that such arguments justify more than protection of endowment returns: state funding for public schools, federal "overhead" payments for research grants, etc. We might even wonder if the endowed universities play a "cost-setting" role for higher education generally. They operate at ever-higher cost, sustained internally by the endowment returns; those costs then help justify the budgets of unendowed schools. "Hey, if you want the kids of Michigan to have a first-rate education, this is what it costs, just look at Harvard." If so, and MIT, Harvard et al began controlling costs, those controls would then ripple over time throughout the whole system through those benchmarking effects. Thus even unendowed schools would have long-term political interest in protecting those endowment returns.)
Note that we don't have to fully believe the whole story to learn from it. The "market" for higher education market is clearly pretty weird, and explaining that will require so pretty involved stories.
This is a very good articulation of my points, thanks for laying it out so crisply. Worth noting that this is already a reality at a select few places. While there is continual agitating in America for our Gov. to provide free college, it turns out that some elite private institutions are already in a position to do so, or will be in the next decade. Food for thought, including the follow-on social implications of the headline: "Tuition Now Free At Harvard! Still $50,000/year At Your Local State University Though"
Regarding agency effects / moral hazard:
Someone asked me on another forum what predictions, if any, I would be willing to make in defense of this article.
I tried to rattle off a few off the top of my head with low conviction. One that I comes back to me still is:
"Professor Salaries will have an increasing Gini coefficient vs. today (i.e. profs at Harvard make a higher multiple of Profs at State Colleges 25 years from now)"
Given that the Top institutions will be competing for talent with Compound Returns while everyone else must compete with Tuition increases, I think this would be interesting to study & observe. I have zero data on this unfortunately, so it's just an unsupported hypothesis for now...
> Professor Salaries will have an increasing Gini coefficient
I think your own model says this is too noticeable. Better strategy would be harder-to-notice changes, like smaller teaching loads, more sabbaticals, earlier retirement, travel abroad to conferences, etc.
The comparison to artificially-constrained SF housing is very apt (as a current SF resident, I know it well).
Most of the money is used to make more money tax free. i.e., it's invested & managed by Wall Street.
Edit to add I wasn't suggesting the type of entity mattered re: 501(c)3 status but rather was pointing out that the endowment fund is an entity separate and apart from the educational institution.
See https://www.irs.gov/charities-non-profits/private-foundation... for details.
I pointed out it's not the university, but the endowment that needs to spend a certain amount to maintain tax-exempt status and that most of it is invested to make more money, which is not an educational purpose.
You've just pointed out that the IRS requires the endowment to make certain distributions. And you've even noted that the IRS required distribution is often much lower than the actual investment income earned. What does this mean? It means even after making the qualified distributions the endowment grows.
Let's say the investment pot has $100 principal and earns 8% a year. At the end of the first year the endowment has $108. Most endowments FBO educational institutions distribute 5% of the total assets:
Year Prin. Int. Dist.
---- ------- ---- ----
1 $100.00 $8.00 $5.40
2 $102.60 $8.21 $5.54
3* $105.27 $8.42 $5.68
4 $108.00 $8.64 $5.83
5 $110.81 $8.87 $5.99
As you can see as the endowment grows the amount of money that needs to be distributed grows as well.
It's interesting to note that the specific rule you've cited came into effect in 1970 precisely because endowments were reaping the benefits of tax-free earnings without actually using the money for the benefit of any of the tax-exempt activities. When did college tuition start skyrocketing? The mid-1970's.
 Professional experience: I'm a securities & investment attorney.
*Edit: Skipped a year's worth of numbers
Not in real terms it doesn't. When was the last time typical moderate risk investments had long-term returns more than 5% above inflation?
If you had $1000 1970 dollars in 1970 and it increased by nominal 3% annually until last year, you would have $4012 in 2017 dollars. That isn't a real >$3000 gain, it's a >$2400 loss (in 2017 dollars), because $1000 1970 dollars is $6418 2017 dollars.
> When did college tuition start skyrocketing? The mid-1970's.
This is also just after the Higher Education Act was passed, giving out low interest student loans.
The asset allocation for a $100MM+ endowment FBO educational institution typically includes about 10% PE, 5% VC, and 20-25% in alts (hedge funds, derivatives, long/short plays, etc). These aren't even close to "typical moderate risk" investment vehicles.
And the bigger the endowment, the bigger the percent allocation to those types of investments. For example, a super endowment like Harvard probably has closer to 50% of the portfolio in alternative strategies.
In terms of average long-term returns they are, if not worse. Major index ETFs have a very inconvenient tendency to edge out actively managed funds as a general rule, and university endowments are no exception.