Massachusetts Should Tax Harvard

Can you believe that the State of Washington actually wants to tax Microsoft? Doesn’t Washington realize that by taxing Microsoft it risks pushing the company to move its headquarters to a lower tax state? And even if Microsoft doesn’t pay taxes it still contributes to the state in many ways by, for example, promoting knowledge creation. Washington wants Microsoft to pay huge sums in taxes just because Microsoft earns astronomic profits. But Microsoft earned these profits through diligence and intelligence. Does Washington really want to punish Microsoft for its hard-earned success?

Washington State, of course, does tax Microsoft. And if Microsoft tried to get out of paying all taxes many college professors would curse the firm for displaying such naked greed. But Harvard University, the Microsoft of the educational world, feels itself entitled to tax exemption.

Some Massachusetts legislators want to tax rich colleges. Under their proposal, as reported on Inside Higher Ed, Massachusetts colleges would pay a 2.5 percent tax on all assets over $1 billion. (The idea is part of a broader push to question whether some colleges with hefty endowments are inappropriately hoarding wealth while continuing to raise their tuitions sharply.) Nine schools, including Harvard and Smith College (my employer), are wealthy enough to be subject to the tax.

The tax would harm higher education in Massachusetts. But almost all taxes inflict harm. Taxing software companies, for example, reduces their output and increases their prices.

Kevin Casey, Harvard's associate vice president for government, community and public affairs, opposes the tax and was quoted in The Boston Globe as saying, “You'd be taxing success here.” But almost all taxes are taxes on success. For example, I just wrote an economics textbook. If the book sells well it will greatly increase my income and so cause me to pay higher Massachusetts taxes. Massachusetts, therefore, would tax my textbook success. But if you want the wealthy to pay more in taxes than the non-wealthy, then you must support taxing financial success.

Kevin Casey also believes that the tax would harm Massachusetts by damaging “stable bedrock institutions." But organizations such as Microsoft could also use this "bedrock institution" argument to argue for their own tax exemption.

Richard J. Doherty, president of the Association of Independent Colleges and Universities in Massachusetts, correctly pointed out that the tax would damage one of the strongest parts of the Massachusetts economy. He said, “It's like Florida taxing oranges.”

Florida, however, does tax its orange industry. A state that didn’t tax its most successful industries would have to impose higher taxes on less successful businesses and so would further impede these businesses’ fortunes.

Taxes are like poison. Taking a lot is fatal, but exposure to small quantities only moderately harms health. The best way for a government to tax, therefore, is for it to spread around its tax poison broadly so no entity must consume too much of it. If Massachusetts is determined to collect a certain amount of taxes from organizations (such as corporations), then it will do less harm if it forces all organizations to pay a little than if it mandates that a subset pay a lot.

A tax on elite colleges would reduce inequality. Students who attend top schools have vastly higher lifetime incomes than other Americans do. And even if the tax reduced financial aid and so increased student borrowing, it would still reduce inequality because those who graduate from elite schools with large debts are much better off financially than are their peers who do not attend college.

The Harvard economics professor Greg Mankiw has suggested that the tax could cause Harvard to move to another state. But whenever a state taxes a business it risks causing the business to flee.

Colleges, I suspect, are far less likely than businesses are to leave a state because of adverse conditions. Yale and the University of Chicago would surely pay a hefty tax to turn their crime-ridden neighborhoods into versions of Stanford’s Palo Alto. Yet both these schools stay put, even when nearly any similarly situated multi-billion-dollar business that sought to attract the best and the brightest (and often the richest) would have long ago moved to more pleasant surroundings.

In his blog Mankiw also writes of how another Harvard professor thinks his institution should act if taxed: This professor proposes that “Harvard can decide to no longer accept the children of Massachusetts residents.” Well, just imagine the reaction if Microsoft, in its anger over being taxed by Washington state, even joked about boycotting all Washington customers.

Although I support taxing rich colleges, I believe there are better ways of doing it than through imposing a wealth tax on endowments. As Mankiw wrote to me, many economists believe it inefficient for governments to tax savings. I would prefer if Massachusetts imposed a sales tax on tuitions. Such a tax might appeal to politicians who don’t begrudge elite colleges their huge wealth but do feel the schools should spend more of their capital on students by, for example, charging low tuitions.