Taxation could be the death of the great research university

One of the central tenets of the overall Trump tax reform proposal is to simplify the basic structure of taxation in order to improve the incentives for growth and to decrease the private and government costs of compliance.

One striking exception to that general program is the tax included in the House bill that taxes investment income of university endowments at 1.4 percent. The tax does not apply to all such institutions, but only to those large institutions whose endowment figures exceed more than $100,000 per student.

{mosads}Small colleges seem to be exempt from the proposal, so that the proposal is targeted chiefly at the major research universities with large endowments and extensive programs for graduate student research.

The program, which has stirred up fierce resistance from universities, is remarkably short-sighted. The easiest way to illustrate the impact of the tax is to show how it applies to Harvard University, which has an endowment of about $37 billion.

In the past year, that endowment generated about 8.1 percent income, which translates into about $3 billion per year in investment income. So, a 1.4-percent tax generates about $42 million in tax liability in this simple example.

The $100,000 per student exemption does not apply because Harvard has a total student enrollment of roughly 20,500, meaning its per-student endowment is about $1.8 million, far in excess of that safe-harbor figure, as are all the other universities whose endowment is even one-tenth the size of Harvard.

The immediate short-term consequences of the tax are substantial relative to the size of deficits and surpluses that are typically under 1.4 percent. The tax is likely in at least some cases to push universities from a credit to a debit position.

The threat here is actually even graver because nothing says that when the government opens up a new source of income, the initial rate of tax is set in stone. The basic reality of political economy is that many systems of regulation and taxation start off with promises that their application will be mild and moderate only for subsequent increases to take place at a powerful level.

Think only of the increases in taxation on income for social security and on all forms of income to support the Medicare tax. Universities could survive this tax, even though it would put a crimp in their operations.

But it is far from clear that they could survive a regime that doubles or triples the size of that tax, insisting that now that the principle of taxation for university endowment is in place, it is petty quibbling about details to challenge any increase in its level.

The truth here, however, is that imposing this tax represents a major, unexamined reversal of federal policies toward universities. The government gives charitable deductions to private donors because that deduction operates as a form of matching grants, whereby the private grantor supervises the way in which the money is spent to help ensure that public funds are also put to good use.

The government also gives huge research grants to universities on the simple theory that these grants fund the creation of public goods for the dissemination of information and the training of the next generation of scientists and researchers.

Last year Harvard set a financial aid record, distributing $414 million in grant assistance to students https://t.co/7pIG33g4oX

— Harvard University (@Harvard) November 6, 2017

These wages and scholarships are taxed at the individual level, so it is not as though there is no tax revenue from these forms of federal support. By the same token, the imposition of any tax works at cross purposes with these programs, for its likely effect, at least at the margin, is to reduce the money available for funding research.

It is commonly said that this tax on universities rides on populist impulses whereby universities and colleges rake in millions while their graduates are swamped in debt. But if there is a problem in that regard, it is not from the elite institutions that are subject to the tax but from weaker institutions whose graduates have bleaker economic prospects.

Nor does it make sense in thinking about universities to assume that the higher tuition figures in some sense gouge particular students. Universities are not profit-maximizing institutions that take in students solely on their ability to pay.

The whole point of a university is to tax some students to subsidize others in order to create an intellectual climate that actually works. Hence, the large increase in scholarship support, which acts as a sensible form of price discrimination.

In addition, those institutions like Harvard, which has 68 percent graduate students, and its peer institutions like Columbia and Stanford, with roughly equivalent numbers, operate in a very different environment from those schools like Brown, Dartmouth and Princeton that have 28 percent, 33 percent and 34 percent graduate students, respectively.

Graduate students cost more to fund, as they are typically on scholarship and their research projects require extensive funding, much of which comes from endowment income. It is therefore disheartening that the House of Representatives should use such flimsy economic rationales to push for a new tax on net investment income, without looking at the purposes for which it is spent.

The simple truth here is that we want universities to expand their reach and operation. The current model has worked especially well in the physical and natural sciences; yet it is precisely those programs that are likely to contract if this misguided Trump administration plan is put into place.

Taxation and regulation could be the death of the great research university. It would be far preferable for the Trump administration to make sure that its deregulatory programs do not stop at the university gates.

A good place to start would be to allow universities to re-impose the mandatory retirement limitations for tenured faculty — a topic for another day.

Richard A. Epstein is the Peter and Kirsten Bedford senior fellow at the Hoover Institution at Stanford University. He is the Laurence A. Tisch professor of law at New York University Law School and a senior lecturer at the University of Chicago.