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Watching Endowments, Not Legislating Over Them

September 9, 2008

If colleges pay attention to what lawmakers are saying about endowments and continue to adjust their payout rates accordingly, new federal laws may not be needed. That was the message of Sen. Charles E. Grassley of Iowa Monday. Grassley, who as ranking Republican on the U.S. Senate Finance Committee has overseen investigations into tax-exempt organizations' practices, spoke at the conclusion of a Congressionally sponsored roundtable on the wisdom of a federally mandated endowment payout rate -- a proposal that the higher education establishment has mightily resisted.

“Not necessarily to give comfort but to say what I have found in other investigations that we’ve done, that would give you some encouragement more so than comfort," Grassley said. "When people look inward at their operations, they find a lot of things that aren’t right that can be corrected, and I would like to encourage you folks -- as there have been some examples already over the last year -- to look inward and see what can be self-corrected and maybe make everybody’s job a lot easier.”

He added: “It’s been really rewarding that when you get people to sit down and think and talk, a lot of things can be corrected without Congress stepping in.”

Grassley had cautioned earlier on, however, that lawmakers can't say what they might do in the future. In the meantime, in keeping with the theme that colleges should be more transparent, Grassley asked the Internal Revenue Service to go beyond the changes it recently made to the informational tax return that all nonprofit entities file, developing an additional Form 990 schedule for colleges similar to one designed for hospitals. “While the new 990 requests some information about endowments, it does not require institutions to report information about their student populations or costs.”

The public policy objective behind calling Monday’s roundtable of high-profile higher education leaders and researchers was to encourage colleges to more freely draw from their (tax-free) endowment funds to control their increasing costs. The roundtable comes in the wake of proposed (and withdrawn) legislation mandating that universities spend 5 percent of their endowment per year, a requirement akin to one in place for charitable foundations. Against the backdrop of increased scrutiny of their growing endowments, a number of universities, most notably Harvard University, have initiated dramatic changes in their aid policies -- but the message from lawmakers Monday was that more colleges could be doing more.

The first hour of the 3.5-hour-long roundtable was devoted to “understanding college costs.” Panelists cited common drivers, including significant declines in state appropriations and the ever-expanding nature of the knowledge production business. U.S. Rep. Peter Welch (D-Vt.), who earlier this year proposed and (under heavy pressure) almost immediately withdrew legislation requiring colleges to spend 5 percent of their endowments each year to reduce the cost burden on students, was only so sympathetic. Welch co-convened Monday’s roundtable with Grassley.

“There's no doubt there are tremendous cost pressures,” Welch said, nonetheless contrasting escalating college costs to the more contained cost of milk, saying if the price of a gallon had risen so rapidly since 1980, it would cost $15 today. “So we’ve all got our problems and the question is how are we going to solve them?”

Welch likewise expressed dismay at what he described as an overblown reaction by higher education and the media to his earlier proposal for a mandatory payout. “The defensive reaction gave some suggestion to at least a few of us that there was a resistance from the educational establishment about addressing what I think is an undeniable crisis about the escalating cost of college education.”

Participants in the roundtable -- much of the discussion was dominated by the presidents of Amherst College and Princeton University, two wealthy institutions; Berea College, an atypical, tuition-free institution that serves low-income students largely from Appalachia; and the University of Vermont -- generally echoed Welch’s concerns relative to access and cost. But they stressed that a mandatory endowment payout rate was not the instrument with which to improve access. And they expressed worry that such an approach would not only be unhelpful, but could also do harm, especially for all the institutions with modest endowments (i.e. most colleges).

"Most institutions do not have the resources of Princeton. For them, a mandatory payout would erode the flexibility they need to be able to increase their financial resources," said Shirley M. Tilghman, Princeton’s president and vice chair of the Association of American Universities.

Speaking of her experience at Princeton, “The total value of the endowment has really fluctuated in just the seven years that I’ve been president,” Tilghman continued. “Had I been in a position where every year my operating budget was going to be significantly influenced by paying a fixed percentage of the endowment value as of June 30 the previous year, I would have been in a boom and bust cycle, as an administrator. I would have had years in which I’d have extraordinary resources to spend. The following year I would be firing people I’d just hired.”

“Such a large percentage of our commitments are long-term commitments. We have to heat buildings, we have to pay tenured faculty members. We have a moral commitment to financial aid.”

The worry that a mandatory endowment payout would compel colleges to spend their resources unwisely was reiterated Monday right alongside another worry that such a requirement could be a drain on colleges’ long-term resources, otherwise reserved for future generations in gestures of “intergenerational equity.”

“Money that’s in an endowment isn’t being wasted, it’s being invested,” said Henry Hansmann, a professor at Yale Law School. “The concern is when it’s taken out of that, where will it be spent? Will it be spent well or poorly?”

“One worries [about] pressing universities to spend money precipitously when they don’t have a great project to spend it on right now. Maybe it’s better if it stays in the capital markets rather than spending it for the sake of spending it.”

On the other side of the issue, Lynne Munson, an adjunct fellow at the Center for College Affordability and Productivity, cited "deep and persistent problems in American higher education that need addressing and that endowment funds could help to address" -- among them low proportions of low-income students at the nation's most elite colleges. Munson also said that any mandate “should be accompanied by guidance that ensures that that spending will respond to public needs. Our universities’ athletic facilities don’t need bigger climbing walls.”

Many of the remarks prepared for Monday’s roundtable focused on obstacles to one-size-fits-all legislation, including the diversity of American colleges (particularly when it comes to their wealth or lack thereof). Another common theme was the restricted donations that comprise a large proportion of college endowments. Money earmarked by donors for the medical school, for instance, isn't available for increasing undergraduate financial aid.

While the obstacles offered by higher education's representatives seemed to counter any potential legislation, Jane Gravelle, a senior specialist in economic policy at the Congressional Research Service, said the challenges to crafting legislation did not seem insurmountable. She said, for instance, that such a spending rule could only apply to colleges with a sufficiently large per-student endowment -- “Leave the universities with small endowments out.”

Welch seemed to echo in his closing statement that such legislation would, theoretically, at least, be possible. “Many of the questions you’ve raised I think have answers to them in terms of flexibility. So if there were a foundation-type requirement, it wouldn’t put handcuffs on your ability to make decisions appropriate to your institutions."

 

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