Universities shouldn’t be tax exempt

By Felix Salmon
July 8, 2013

I have a piece up at Architect Magazine on Cooper Union, and the real (if slim) possibility that it will lose the tax break from which most of its current income flows. Cooper Union will get $18 million this year in “tax equivalency payments” stemming from its ownership of the land under the Chrysler Building — money which would normally flow to New York City in the form of property taxes, but instead gets diverted to Cooper Union for its own uses. Do the math, and that works out to about $18,200 per enrolled student — a much greater subsidy than New York City provides to any of the students being educated at its own colleges.

Doug Turetsky, of New York City’s State’s Independent Budget Office, says that if Cooper is going to start charging tuition, then “the public purpose of the unusual tax breaks now mostly a thing of the past,” and New York should start collecting property tax on the Chrysler Building rather than letting Cooper Union use all that money for itself. So far, there’s no indication that the attorney general agrees with him; as I say in my piece, the time for the AG to crack down on Cooper was in 2006, rather than now, when the removal of the tax break would mean certain death for the college.

Still, in an ideal world, Cooper Union wouldn’t get this tax break — and neither would NYU be exempt from paying property tax on its buildings, and neither would Harvard be able to invest its endowment tax-free. The tax exemptions that universities receive cause them to behave in a manner which would otherwise be quite irrational: NYU’s expansionism, for instance, is driven in part by the fact that it can extract more economic value out of property than other actors, thanks to all property it buys automatically becoming tax-exempt. And if you look at Harvard’s balance sheet, it has for decades now been a hedge fund with an educational institution attached, the educational institution more than paying for itself in the tax exemption it confers upon the entire endowment.

The dollar value of universities’ tax exemptions is enormous — and it almost goes without saying that if we simply abolished those exemptions, and used the proceeds to spend on higher education, we would get vastly more bang for our buck. The overwhelming majority of the tax expenditures go to the richest universities — the ones who need the money the least. Meanwhile, great institutions like the University of California are slowly starved to death: direct fiscal expenditures, it seems, are much, much easier to cut than more-hidden tax expenditures.

If state and federal governments are going to spend billions of dollars subsidizing tertiary education — and they should — then they should spend those billions wisely, with a focus on education. Instead, they spend those billions through the tax code, with no kind of oversight at all, pushing their thumb on the scales so as to encourage, at the margin, the purchase of buildings and the building-up of large endowments.

A revenue-neutral abolition of universities’ tax exemptions would be a massive gain for pretty much everybody, even if it did have the effect of slightly reducing alumni giving. In fact, it would be a very interesting real-world experiment: if alumni giving didn’t drop very much, that would be a good reason to extend the abolition to the entire charitable-giving nexus more broadly.

I don’t think that Cooper should, or will, lose the tax equivalency payments it receives from the Chrysler Building — they’re no more odious than all the other tax exemptions received by universities across the nation. But if all colleges lost all their exemptions, and got their federal subsidy directly instead of indirectly — now that I would applaud.

Comments
6 comments so far

I have no idea what the headline means. Universities generate no net income as a group at all. They get billions in government grants, tuition, all of it spent. The top 10% might get a 10th of their revenue from their endowment income. Only the top 50 or so schools (out of 2,500+/- colleges) make any real endowment income, but again most of that is still spent on lavish campus improvements, football stadiums, and generous faculty and admin salaries.) Unless you’re talking about property taxes there is not a lot to talk about. Even property taxes are overblown… in many towns we force colleges to make a payment in lieu of taxes anyway.

Posted by y2kurtus | Report as abusive

Property taxes are exactly what Felix is talking about, and they can end up being fairly significant. In New Haven, for example, Yale has tax exempt properties whose total assessment runs at about 1-2 billion dollars. With the current mill rates, this works out to be a tax burden of $40-80 million. This is significantly more than the ~$8 million that Yale charitably gives to the city. For a city of 130,000 people, I don’t think you can call that discrepancy overblown.

If universities ended up paying property taxes (and just received subsidies from the government), it might encourage them to limit the purchase of large plots of land and construction of glamorous buildings. Maybe then they could focus more on education.

Posted by cmckitterick | Report as abusive

y2kurtus, your points about stadiums is well made.

Top level athletics at university more closely resembles slaves at the oars of a galley ship than it does education.

Certainly, it the size of Harvard’s endowment is obscene, and proposals (now dead) to tax it are well founded.

One of the problems here is that the top level universities have a pricing oligopoly (Clinton let them get away with it), but, as per classical economic theory, they continued to compete on a non-price basis, hence bidding up academic salaries, gilded dorms, etc.

The real question here is whether the tax exemption better serves the public good than does the tax revenues, and I, and Mr. Salmon, would argue that it does not. (Yes, I know that the same applies to religious institutions, but I oppose tax exemption for them as well)

Posted by Matthew_Saroff | Report as abusive

The best study I’ve seen of the value of tax exemptions in higher education was done by the Tellus Institute last fall, as a case study of Northeastern University. Local property tax exemptions were the biggest chunk. But they also tabulated state excise, income, and sales taxes, and federal income and investment income taxes, as well as the indirect subsidy of tax exempt bonds to fund construction. They found that, in 2011, Northeastern’s tax subsidies amounted to $94.4 million – actually outstripping all other governmental support. (All federal research grants, contracts, and federal student aid tallied just $87.33 million.)

Now, Northeastern isn’t exactly poor – most public institutions of higher education would kill for its ~$600m endowment. But that endowment ranks 134th in the United States, so it’s not exactly in the top tier, either. And I would submit that, instead of basing public policy proposals on their impacts on extreme outliers like Harvard and NYU, it probably makes more sense to look at a middle-of-the-pack place like Northeastern.

What would happen if Northeastern were stripped of its tax exemptions? Because if you revoke the federal status, you can be sure that the state recognition will also disappear. First, its local real estate taxes would jump by $38.64 million on an annual basis. That would certainly be a short-term boon to Boston’s municipal finances, but I wouldn’t expect to see the city kick a single dollar back in subsidies. Next, state revenues would jump by $22.92 million. And finally, the Feds would take in another $32.84 million.

So what, exactly, are you proposing here? That the Federal government plow the combined value of the tax exemptions – $94.4 million – back into higher education? That’s an interesting idea. But as a practical matter, the Feds would have to find a way to cover the $60 million difference between their increased revenues and the value of the exemption. If they did, the biggest impact of this scheme would become a massive subvention of funds to support municipal and state finances. Or are you suggesting that the Feds remove subsidies worth $94.4 million, and replace them with new direct funding sources worth only the $32.84 million that they would be saving? That’s a more practical idea, but it’d amount to a massive slashing of funding for higher education.

But of course, the situation created by a targeted repeal of tax exemptions for universities would likely be even more vexing. I’d expect to see private institutions transfer all the assets they can to an affiliated foundation, keeping them sheltered from taxation. Mammoth endowments would be the easiest to shelter; real property would probably be harder, depending on how the laws were written. So the Feds, who tax endowments, would probably have a much harder time actually recapturing all of this potential revenue than local governments, which tax property.

A revenue-neutral scheme sounds tempting in the abstract – and it’s certainly the case that some universities have abused their tax exemptions to indulge in empire building. But in practice, it would either mean massive cuts to higher education, a massive new transfer of federal revenues to state and municipal governments, or some combination of those approaches.

There’s one other problem worth mentioning, and that’s the relative merits of direct and indirect subsidies for universities. We’ve actually run this as something of a controlled experiment. The states fund public universities primarily through direct expenditures; we all subsidize private universities primarily through tax expenditures. Over the last few decades, we’ve seen a progressive defunding of public universities and cost-shifting over to students and families – a trend that has hit the most vulnerable the hardest. Private universities, by contrast, have found their tax expenditures to be extraordinarily stable and reliable, in good times and in bad. So independent of the problems of implementation, I have a tough time buying the notion that a transition to direct expenditures would actually remain ‘revenue neutral.’ That might be the case in year one. But are you building an escalator clause in? It almost doesn’t matter. Direct expenditures aren’t going to increase; they won’t even remain stable in nominal dollars. At the first hint of economic contraction, universities will be a tempting target for austerity, triggering waves of cuts and cost-shifting to students. And the consequences of systematic underinvestment in higher education are far-reaching.

I’m not fond of NYU’s real estate games, either. But I don’t think this is the solution.

Posted by Cynic | Report as abusive

Cynic seems to think that the government will need to subsidize the University to make up for the lost benefit of taking away their tax exemption.

If the federal tax exemption is worth $32.8 million to Northeastern, that means that it made nearly $100 million in profit. That’s $5,000 per enrollee at the university.

So explain to me, with that level of profit, why does it to be subsidized?

Posted by johnglover | Report as abusive

I couldn’t agree more with abolishing property tax exemptions for universities. In a city like mine (ypsilanti, mi) we are only 4 sq miles but majority of it is taken up by EMU. And then when pfizer moved out of ypsilanti guess who bought up that massive building and land… university of michigan. It creates such an overwhelming burden on the local municipalities to raise money to cover even the basic expenses. The result is bleeding homeowners dry in taxes. I pay 4k a year on a home only valued at 115,000. The most painful subsidies come at the cost of the residents where these universities are located.

Posted by parzle | Report as abusive
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