Thursday, December 28, 2017

Mankiw on endowment taxes

Greg Mankiw wrote a New York Times column December 24 criticizing the university endowment tax. I disagree, not so much with the wisdom of the tax, but with the wisdom of writing such an article.

The tax is small -- 1.4% of endowment income. So if $100 of endowment earns 10%, or $10 of income, the university pays 14 cents. Still, with $38 billion of endowment like Harvard's, or $22 billion like Stanford's that adds up to some real money.

Greg writes that it is "hard to justify this policy." Universities invest in "human capital, which means educating our labor force" and "the knowledge that flows from basic research." Mainly, though, Greg's against the tax because the few elite universities with more than $500,000 endowment per student, (unlike the community colleges and state schools that actually do train the labor force)
"use their resources [to offer] need-blind, full-need admissions...."
"At Princeton [$24 billion] about 60 percent of undergraduates get financial aid. This aid covers the entire cost of tuition, room and board for students from families with income below $65,000 a year."
In sum, Greg feels that universities provide a public good, of refraining from charging tuition for low-income students, so should retain this subsidy. And subsidy it is. While I think all capital taxes should be zero for everyone, given that everyone else pays capital taxes, the fact that universities can borrow at tax-free rates, accept tax-exempt gifts, put the money into endowments which are run like funds-of-funds, hiring high-priced managers to send money to high-priced managers of hedge funds, private equity, venture capital, and real estate, and pay no tax on dividends, interest, capital gains, ever, amounts to quite a subsidy relative to everyone else. And it comes out of taxes that universities do not pay, which means everyone else pays more.

Lower rates, broaden base?

Does not every claimant on the public purse, anxious to preserve a tax deduction, claim that they provide a public good? The home builders, the mortgage bankers, and the real estate agents went apoplectic over limiting the deductibility of home mortgage interest. Because it was going to destroy the American Dream of Homeownership. Because building home equity is the tried and true, well, "engine of economic growth for the middle class!" Farmers demand agricultural subsidies to defend their storied way of life. Why, without the Family Farm, the fabric of American society is lost! The bankers demand immense leverage, deductibility of corporate interest, and a range of anti-competitive regulation because otherwise, who will lend to the middle class!  The solar cell and electric car manufacturers want tax credits and subsidies because they're saving the planet. And on we go.

Conservative, "Republican," free-market principles used to be to advocate for lower marginal tax rates, and a broader base, in which everyone gives up their little deduction or subsidy. (I use "Republican" as Greg uses it, so don't go all nuts in the comments about Republican failings to live up to these ideals.)

How can we credibly proclaim that we, universities, provide the true public good and deserve subsidies, but the rest of you get lost? Do we not look just a little hypocritical if when a tax reform is announced, we jump in line with the rest of them to demand our pork back?

Greg started his oped well:
"The tax legislation approved last week by Congress....combines some badly needed reforms with various messy provisions seemingly designed to keep accountants and tax lawyers fully employed."
The reason it ended up that way is that the minute it was announced, every Tom, Dick, Harry, Susan, and Jane rushed to Washington to protest losing their deductions and credits, and given that passage relied on reconciliation rules, no democrats and a tiny margin in the senate, Congress caved in quickly. The hope to lower marginal rates and broaden the base got swiftly rolled back. (There is some progress -- state and local and mortgage deductions are limited. But a lot less than we have hoped for these last 31 years.)

Should not the role of a renown economist, public intellectual, like Greg, to be to explain lower the rates broaden the base from the rooftops -- and when the time comes, to say that yes, we will give up our subsidies, and we will in doing so lead the fight for everyone to give up theirs too?

Yes, this is a tiny tax, in a bill that only begins to cut deductions. But if there is any hope for reform, our time will come. If we want to lower rates and broaden the base, we will have to cut the holy trinity -- employer health care, charitable, and mortgage interest. While there are many worthy charities and nonprofits, including both Greg's and my employers, charitable deductions and nonprofits have become a cesspool of tax shenanigans and politics. When the time comes that a real cut is on the table, will we say, "yes, we accept ours too,"  or will we run to Washington to plead "everyone else yes, but spare us?"

How to subsidize

Moreover, if indeed universities provide useful public goods -- and they do, and I  include low tuition for low-income students and basic research -- surely how that activity is subsidized matters. There are good and bad ways to subsidize anything. That is a second "principle" of good conservative, "Republican" and free-market governance.

Usually, giving a lot of money to a large opaque and competition-protected bureaucratic institution that does a lot of things, to spend as it wishes, does not produce the outcome you want. Usually, funding that subsidy by giving a franchise such as a little monopoly or the unique opportunity to run a tax-shielded hedge fund does not produce the outcome you want.

When you want  a public good from such institutions, conservative principles usually suggest that the subsidy be transparent, annually appropriated, reviewed, and given for the activity you want. Give federal scholarships to the students, chosen by federal rules, and studying things that taxpayer representatives find useful. Support research through competitive grants. Perfect? No. But a lot better than counting on tax-subsidized endowment profits to go where you want them to go.

Otherwise, you tend to get big administrative bureaucracies, sports and recreation programs, bloated faculties with high salaries, low teaching loads and a lot of silly research, and a few crumbs to the worthy students. You also get admissions offices selecting students by all sorts of crazy criteria suiting the admissions office, including some rather stunning obstacles to asian-Americans. If the taxpayers are footing the bill -- and they are here -- shouldn't they get some say in who gets the goodies and what they do with them?

So, if sending low-income students to Harvard and Princeton is a good idea, conservative, "Republican" and free market principles direct us to argue for a direct, budgeted subsidy, not a hidden special opportunity to run tax-advantaged hedge funds on the hope universities will spend the profits in some publicly useful way.

Just in time, the WSJ "notable and quotable" which seems to be running a series on abstract abstracts from academic journals ran a good one. From the original source, Stephanie Springgay writing in the journal Research in Eduction,
The idea that the world is composed of moving and constantly transforming materialities that are vibrant, quivering, and indeterminate has shifted how we think about human and non-human relations. Matter is not a stable entity, but one that is continuously vibrating and differentiating. This materialism is crucial for thinking about possible futures of educational research. In this paper, I turn to the materiality of rhythm, movement, and affect to suggest a more vital understanding of participation and thus politics... 
It goes on like this.

Really, Greg? Taxpayers should support more of this "basic research?" (Yes, argument by anecdote is unfair, but this is a blog, and we're having fun.) Is this not an example of what happens when you hope that public goods are supported by an obscure wealth transfer, rather than on-budget spending? (Again, there are plenty of horror stories at the NSF too, but at least they are transparently linked to the subsidy.)


Greg does not question why such universities charge tuition ($43,450 at Princeton) in the first place, then pat themselves on the back for using endowment payouts to pay themselves this tuition for favored students. Nor does he discuss the  incentives that income-based and asset-based financial aid leads to. Greg is usually on top of marginal tax rates. (Hint, if you're anywhere near this income class, with a kid that can get in, working harder or saving a few pennies for college will cost you dollar for dollar in less aid.) Greg calls such "well-endowed universities "engines of economic growth for the middle class." Greg does not address what fraction of "middle class" students are admitted to Harvard, Princeton, Yale, Stanford or other universities with half a million per student endowment.  Is it 0.001%? Community colleges are the engines of economic growth for the middle class.

After the excellent first sentence, above, Greg writes
"the part of the bill that most disappoints me is.. a new tax on large university endowments. " 
(my emphasis.) I can think of a few greater disappointments! (And, to be fair, hopes for future reforms if this is successful. They did limit mortgage interest. So it's just a low voltage plug, not a third rail.)   

Greg notices that some of this tax may be blowback for the uniform partisan sympathies of major research universities.
"Senartor Kennedy then said 'and they're from Harvard. For all I know they are a bunch of weenie liberals. Probably were if they're from Harvard.'" 
Greg points out that Senator Kennedy was wrong in this case, as he was referring to Robert Barro, But the Senator was right on conditional probability. Beyond Greg, Barro, and Feldstein just how many self-identified Republicans are there at Harvard?

Greg also writes
"Most professors leave their ideology at the door when they teach the next generation of leaders"
That isn't even true in economics, and a wispy dream in the humanities. (For an example, just see my next post.)

Greg is, I think, right that this some of the endowment tax is blowback. If conservatives remain in charge in Washington, and universities keep going as they are now, it may only be the beginning.


  1. This tax bill is a start. It's a small step in the right direction. It's no where near perfect as you say, but it's better than what we had. Mankiw is wrong. Endowments were never meant to be tax free hedge funds which is what the large ones have become.

  2. Mankiw frames this as if "tuition" is a "cost" of education.

    Tuition is not a *cost* of educating our future generation. It is a *payment* to the university for those costs. In other words, Harvard's endowment earnings pay for Harvard infrastructure, management and professor's salaries, etc. I thought economists understood this and I would be more impressed if Professor Mankiw would be more upfront about it. Those tax-deductible contributions to the endowment and the tax-exempt earnings go to subsidize those payments which ultimately don't end up in the pockets of students. How much of that taxpayer subsidy goes to Harvard teacher and management salaries?

    And, perhaps a subject for another day: "carried interest" is a tax rate arbitrage play in which partners who are exempt from US tax (and thus who don't care if their allocation of partnership income is ordinary or capital gain) trade their capital gain allocation to managing partners in lieu of part of the fee they would normally pay (capital gain is not "converted" to ordinary income--it is *traded*).

    I challenge Greg to write his next NYT OpEd on *that*.


  3. Although not immediately obvious, the recent tax bill should actually be considered a tax cut for university endowments. By reducing the corporate income tax, the capital gains and dividends received by owners of corporate equity will increase. Because universities are among the largest owners of corporate equity, they will see a substantial increase in income from their endowments due to the tax bill, even after the paltry 1.4% tax on large endowments.

    1. I made this point in a previous thread. The question the corporate rate reduction raises is whether dividends should continue to be exempt from the unrelated business income tax.

  4. This tax isn't about student tuition at all--- except for Berea College, which does charge zero tuition and which lobbied to get the limit changed to $500,000/student so they'd escape the tax. We have lots of tuition subsidies, targeted. Rather, it's about how to deliver research subsidies. Research is a public good--- even silly research, given that it's hard to tell what's silly, though the post has a point that maybe humanities research has low enough average value that it should be excluded altogether (*average*, not max).
    But why subsidize research by exempting endowment income? And why exempt it at all for colleges, places that teach rather than do research? Endowment income is like Jensen's free cash flow, which enables the managers to waste money as they like until a takeover occurs---except with nonprofits, you can'd do a takeover, so the rot persists.

  5. "How can we credibly proclaim that we, universities, provide the true public good and deserve subsidies, but the rest of you get lost?"

    That's the definition of the word "elite", in its negative connotation.

  6. Actually, research is directly subsidized, to the tune of billions of dollars a year.

    BTW: Prof Mankiw lifted, without attribution, his argument about Princeton's tuition from a column George Will wrote a few weeks ago.
    Will is a Princeton Alum and a former trustee.

  7. I don't buy the argument that research performed at US universities or the resulting discoveries are a "public good". If these goods were truly public, universities (and/or their researchers) would not be allowed to patent their ideas and privately profit from their discoveries. "The public" ends up paying twice and the universities end up profiting twice from this system. Not only does the "public" subsidize this research (through direct grants and indirect subsidies due to the tax deductible status of contributions and the exemption of endowment earnings), "the public" then has to pay for the results of that research!

    This situation was exacerbated with the passage of the Bayh-Dole Act in 1980 which overturned the then existing rule that patents to discoveries funded by federal grants had to be turned over to the government. Given the massive existing disparity between the tax treatment of "public" and "private" research, it takes a lot of chutzpah to argue against a measly tax on Harvard's enormous hedge fund and complain about "subsidies" granted to "private" research.

    Another suggestion for Greg's next NYT OpEd: Why, if his best-selling economics textbook is a "public good", he's allowed to sell it at exhorbitant prices to students at significant private gain? He may also explain to the good readers, how, given this situation, the time he spends on writing and updating that textbook are in no way subsidized by taxpayers, or the quantity of books sold and the price students pay for that book is not upwardly affected by the government subsidies they get, directly and indirectly, to buy them.

    Look in the mirror, Greg. You've got some splain'in to do.


  8. As long as contributions to universities are tax deductible, it seems strange not to comment on the discontinuity that taxation of endowments creates. If contributions to a university are 100% deductible, why tax dollars that are already at the university? (Which is really what this proposal is doing.)

    I think John may have even pointed out in a prior post that this should be possible to structure around. Have Princeton contribute half of its endowment to the "Princeton Fund" that is a charitable organization with the purpose of paying tuition for deserving students at Princeton. This would lower Princeton's endowment below the taxable threshold and the earnings of the new Princeton Fund would escape taxation as they would not be an endowment. Depending on how the new tax provision is written, you might need to jump through a few more hoops, but I would bet that something like this is possible because of inconsistent treatment I describe above.

  9. Well said! but the BEA is a public good ... right?

    1. There are many public goods. The BEA (bureau of economic analysis) is one of them. Economics relies on data, and at the moment BEA data is vital. Perhaps someday Google will give us all the data we need, but that day is long away.

  10. I agree. I thought Mankiw's article was very weak and the stuff about Congress's purported motives in doing what it did are of course irrelevant to the economic argument. Makes you wonder about the intellectual substance of a field like economics when a leading practitioner can write something so obviously self interested but cloaked in the mumbo jumbo of the profession.

  11. Note that the endowment income tax is a tax on capital income, and so is subject to the usual criticism that capital taxation is double taxation (you're taxed on your labor income, and then you're taxed on the interest you earn on the parts of your labor income that you save). In this case, the labor income itself may not be taxed, as being donated, but the point still holds, as one commenter said above I think, that we are discouraging donations somewhat by taxing the interest the university earns on hte donated money. 1.4% is a very small capital tax, though.

  12. I'm a former student of yours. I wrote this article for Business Insider supporting taxing colleges:

  13. "Yao Ming? Sounds like he's Chinese, so I'm probably taller," and other conditionally correct statements. Defense of ignorance can only go so far.

  14. Sure there may be more efficient ways to subsidize the public goods that universities provide, but you could say the same thing for the public goods that most non-profit organizations provide. Why does the new tax law target university endowments, and not say, the Red Cross endowment or the NRA Foundation endowment? That's why the new tax bill smacks of peevish political spite rather than anything resembling a rational tax policy.


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