University Endowments, the TCJA, and Firm Behavior

September 26, 2024

I mentioned yesterday my interest in higher education institutions. But “interest” isn’t exactly the right word. For years, I have been borderline obsessed with this particular flavor of nonprofit. Well, them and the work of Ronald Coase.

And I think Coase would have had something to say about the corporatization of the university over the last several decades, which has only sped up in the 21st Century. By this I mean that nonprofit universities increasingly resemble their for-profit, corporate counterparts in terms of their behavior. Their technology transfer offices are the beachhead of rent-seeking behavior on campus. See also the college sports landscape in 2024. Furthermore, the endowments universities control are vast, and they have every incentive to stockpile the return their investments generate. That is, of course, until the 2017 legislation known as the Tax Cuts and Jobs Act enacted an excise tax on the endowments of certain private universities with particularly large endowments relative to their student enrollment. But because the impacted universities are otherwise tax-exempt, might these corporate-lite universities seek to avoid the tax or reduce their tax burden?

This question is at the heart of a new study I co-authored that is forthcoming in the Florida Tax Review. Here’s the abstract:

The 2017 law known as the Tax Cuts and Jobs Act (TCJA) enacted a tax on private, non-profit college and university endowments for the first time. Institutions with at least 500 tuition-paying students and endowments of $500,000 or greater per student now have to pay a 1.4 percent tax on their endowments. But like all taxpayers, colleges and universities may be tax averse or seek reductions in their tax burdens. That is, colleges and universities may try to avoid the tax through taking action to ensure they do not meet the threshold. Such actions include increasing their student bodies, increasing student aid to ensure a small number of tuition-paying students, and spending down their endowments. Colleges may also attempt to offset taxed revenue by increasing other revenue streams. Examples of such behavior include increasing revenue from auxiliary services, admitting more “full-pay” students who do not need financial aid, reducing financial aid for tuition-paying students (perhaps even while increasing the number of students who receive enough aid to become non-tuition paying), and admitting fewer low-income students. All of this would be economically rational behavior, but it could produce negative effects for higher-education stakeholder groups, such as students and their families.

In this article, we assess the ramifications of the TCJA’s endowment tax for college and university revenue-seeking behavior. We use a national-level dataset and a quasi-experimental statistical model known as the “Synthetic Control Method,” which is underutilized in legal research, to examine institutional behaviors in the wake of the TCJA’s passage. We find that individual institutions—such as Northwestern University, Duke University, and Vassar College, among others—may have changed their admissions, enrollment, and revenue-generating behaviors to reduce their overall tax burden, offset losses in revenue, or avoid the tax. We suspect that this is evidence of firm behavior to game the endowment tax imposed by the TCJA.

I should note that, because of its statutory hook, the tax doesn’t apply to many universities; 58 universities paid the tax in 2022, for example. But for the impacted universities, the tax could represent a nontrivial tax burden. Thus, they may be incentivized to game it—and that’s more or less what we found when we looked at certain impacted institutions.