Thursday, January 11th, 2018
As stewards of capital for non-profit institutions, Verger Capital measures our success in part, by how successful we are in supporting our investors’ ability to pursue their mission and serve their beneficiaries. Therefore, it is through that lens that we consider the recently passed tax legislation and its potential impact to higher education and its primary stakeholder, the student.
The populist tone that ushered in the current administration is evident in the recently passed Tax Cuts and Jobs Act (H.R.1) passed by Congress to close out 2017. The key points of the bill we identify below have the potential to reduce financial aid and limit access while simultaneously increasing administrative expenses at colleges and universities.
The “above the fold” headline for higher education endowments is the imposition of a 1.4% excise tax on net investment income. This tax will initially affect roughly 30 private colleges and universities and will generate a projected $1.8 billion (Inside Higher Ed) in new tax revenue into the federal government. In our opinion, this tax is a clear swipe at the “elite” schools; however the true impact will extend beyond the coffers of these institutions with unintended consequences manifesting themselves in the form of higher costs and the reduction of financial aid available to allow students to pursue a degree.
Many of the schools that will feel the impact of the excise tax are among the most generous when it comes to providing financial aid to students. For example, in 2016 Harvard distributed a record $414 million (Harvard Gazette) in grant assistance to students. At Notre Dame, roughly 70% of undergraduates benefited from $233 million (2016-ND.edu) in financial aid provided by the University. The Fighting Irish project the new tax will cost the school roughly $6-9 million per annum (Fundfire) or illustrated more graphically, the equivalent of roughly 40 scholarships based on prevailing ND tuition. Perhaps the most egregious casualty of the new tax is Berea College in Kentucky. Berea has a $1 billion endowment, enrolls 1600 primarily low-income students, and charges no tuition. The projected cost of the excise tax to the college is roughly $1 million per annum, which translates to 10 students possibly losing the opportunity to pursue a degree based on Berea tuition data published on their website. Yes, these are exceedingly wealthy institutions but through grants and aid, they are opening doors and creating opportunity for those who otherwise might not be able to cross the threshold.
Colleges and universities have historically been the beneficiaries of a consistent inflow of charitable gifts from alumni, parents, corporations and others. In 2016, donors gave roughly $41 billion in gifts to higher educational institutions up slightly from $40.3 billion in 2015 (Inside Higher Ed). Aside from the altruistic, feel-good component of such charitable giving, our tax code has heretofore encouraged such giving through the ability to reduce liabilities through itemized returns.
Section 1002 of H.R.1 roughly doubles the standard deduction available to individuals filing returns potentially negating the tax benefit of charitable giving for some taxpayers. According to The American Council on Education, roughly 30% of taxpayers that itemize enjoy the charitable deduction. Their research indicates that a doubling of the standard deduction would drive that figure to 5% and significantly reduce charitable giving to higher education but also more broadly across the non-profit sector.
H.R. 1 further limits the availability of funds to support students, faculty, programs, and operations through potential increases in administrative costs. As passed, the bill may increase cost of funds to institutions though elimination of the interest exclusion for advanced refunding of outstanding bonds, drive new tax revenue through recalculation of UBIT, and levying excise tax on compensation deemed excessive.
While the 1.4% excise tax on net investment income will only initially affect approximately 30 schools, we are concerned that it could potentially be an opening shot across the bow for the higher education sector that has come under fire in recent years for largess. Reminiscent of the children’s book by Laura Numeroff “If You Give a Pig a Pancake” where the moral of the story is always a want for more, the fear is that H.R. 1 could be the first ask, and at some stage, its reach extended beyond the initial scope. However at what cost and to whom? A college education can be a pathway to opportunity. If that path is blocked or inaccessible, the brunt of the impact will be felt by students, our communities, our economy, and most ironically, by federal tax rolls absent optimal participation.
At a high level, we see the impact of H.R. 1 limiting access to select institutions through reducing the availability of direct financial aid and discouraging charitable giving to higher education (and beyond) through an increase in the standard deduction. Additionally, administrative costs may increase due to the recalculation of UBIT, an excise tax on certain employee compensation, and changes affecting bond refunding.
At ground level, in the classroom where young minds meet their future, we see lost opportunity.
Verger Capital Management LLC does not provide legal, accounting, or tax advice