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November 14, 2017

HIGHER EDUCATION BUBBLE UPDATE: A Hedge Fund That Has A University: Taxing endowments’ investment income would help higher ed.

Whatever you may hear, the Republican tax-reform proposal isn’t an assault on higher education. The House and Senate plans include a new 1.4% excise tax on the net investment income of university endowments, but the levy applies only to private colleges with at least 500 students and endowments of more than $250,000 a student. Schools like Harvard, Yale, Stanford and Princeton—which together hold over $100 billion—are predicting doom. Yet this long-overdue tax will benefit higher education in the end.

Over the past 30 years universities have chased higher returns on their endowments, leading them to take greater risks. Our research shows that more than 75% of the assets in university endowments are now in risky investments: securities, hedge funds and private equity. Think of Harvard as a tax-free hedge fund that happens to have a university.

The proposed levy on investment income—dividends, interest and capital gains—is fundamentally a tax on this risk-taking, not on the endowments themselves. By taxing risk-driven income, the GOP plan doesn’t target higher education. It goes after hedge funds masquerading as university endowments. . . .

A large and risky endowment also reveals a university’s poor assessment of its internal investment opportunities, such as scholarships and research. If Harvard and Stanford have educational and research projects that could benefit from additional funds, why put their money at risk in the stock market? Perhaps the answer is that the opportunity to run a tax-free hedge fund is too attractive. In that case, why should taxpayers subsidize their activities?

Why, indeed?