Allegations and Public Policy: The Case of University Endowments

by Robert A. Scott


University endowments in the United States are as old as the institutions themselves. Harvard University, the oldest, was endowed with books and land by John Harvard. Most early endowments consisted of land. Yale University is also named for its original benefactor.

The purpose of endowments is to provide core support for the long term. An endowment is not a “rainy day” fund. Unlike corporations with quarterly reports scrutinized by financial analysts, many universities are centuries old, and make decisions with long-term horizons. Endowments are intended to provide ongoing stability. Endowed funds also leverage other sources of financial support, such as government student aid, and can encourage innovation and flexibility.

Unfortunately, there are those like Malcolm Gladwell, the son of a mathematics professor, who said that university endowments are “obscene” and called for institutions to renounce their tax-exempt status. In doing so, he joined a chorus of mostly Republican legislators in decrying the wealth of some institutions. The theme seems to be supported by an “anti-elite” mind-set.

In 2017, in response to complaints about the size of some endowments, Congress passed the Tax Reform Law which imposed a penalty on the largest. The new law imposed a 1.4 percent excise tax on net invested income from endowed funds at institutions with over 500 students and per student assets of over $500,000. It was reported that this will cost Harvard University nearly $38 million a year, money that will not be available for students and will do little for the US Treasury.

However, most institutions do not have significant endowments. According to a recent report by Ithaka S+R, “…1,375 public and private four-year institutions reported a total of $475 billion in endowment assets at the end of FY 2016, an average of $346 million per institution and about $52,000 per full-time equivalent student.” It should be noted, however, that just 23 institutions accounted for one-half of the assets. The other one-half was shared by the other 1,352 campuses.

In fact, according to the American Council on Education, only about 16 percent of colleges and universities have endowments of over $50 million; 54 percent of private colleges and universities have endowments of less than $10 million; and the median endowment is about $8 million.

What critics of endowments seem to ignore is that they are not a single fund, but multiple funds from different donors. In addition, the bulk of endowed funds are restricted in use by those donors. Donations for faculty positions or research centers or athletic coaches cannot be used for student financial aid. So, a university might possess a million dollars or more in endowments per student, but only a portion of that total may be used to support students. This is a problem of incorrectly comparing a denominator and a numerator.

Endowed funds are of three types. The primary type is restricted in purpose by the donor. A second type is called “quasi-endowment” or “funds functioning as endowment.” These are funds generated from unrestricted gifts or savings and are reserved for designation by the board of trustees. The third type of endowment is the “term” or expendable endowment. In this case, the donor specifies that the funds should support a purpose or purposes for a particular period of time, not in perpetuity.

It is estimated that about one-half of endowments support financial aid for students, with some additional funds restricted or designated for student academic support. The remainder is restricted or designated for purposes such as faculty positions, particular academic departments, research centers, and similarly specified uses.

Endowments are controversial in part because some are so large. Yet they are legal. They result from donors exercising their rights under the US tax code, the same code that gives citizens the right to donate tax-deductible funds to their religious institution. Boards of trustees are obliged to review the intention of the donation, assure that it conforms to the publicly approved charter of the institution, and is related to campus priorities. There are examples of universities denying gifts and returning the money. There are also examples of donors asking for their gift to be returned because the purpose was not being fulfilled.

Some argue that universities with the largest endowments should not charge tuition. It is possible to show that the amount of endowment per student is sufficient to generate enough income to offset the need for tuition. However, since these same institutions tend to enroll large numbers of students from the top 0.01 percent of family income, such an action would subsidize the already well-off. Others argue that these large endowment universities and colleges should use the money to increase the number of students from low-income families. This is something that many have already set as a goal on which they are making progress. They charge no tuition for students from families within a certain income range and students can graduate free of debt.

Others argue that universities should increase the rate of spending from their endowments. Most institutions follow a policy of drawing 5-7 percent of a three-year rolling average of total market value to support the operating budget — whether the stock market is up or down. Universities must follow both legal and accounting rules regarding endowments whose value becomes less than the obligated pay-out. This guidance helps institutions in adopting a spending rate that will help maintain value for the long-term whether the market value is up or down.

Using an average spending rate of 5 percent, it becomes apparent that a median size endowment size of $8 million would yield about $400,000. Furthermore, if one-half of the income is restricted or designated for purposes other than student financial aid, the $200,000 remaining would not support many students. This is why most institutions, including some among the most prestigious, must discount a portion of tuition in order to provide both need-based and merit-based scholarship assistance.

Others argue that universities should not seek a maximum return on their investments but simply maintain their value over time. Most university investments follow the traditional advice of maintaining allocations in various investment classes over time and adjusting when necessary to maintain consistency. The goal is to neither hoard nor overspend.

As the late David Riesman said, the role of the board of trustees is to protect the university of the future from the actions of the present. An important tool for protecting the campus of the future is to be responsible stewards of funds donated as endowments for future use. Therefore, it is essential for us in higher education to educate the public and elected officials about the purposes and uses of endowed funds so that policy will be based on facts instead of fiction.

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