The 5% Non-Solution

In the public policy echo chamber of Washington, where simplicity and slogans often reign, the idea of requiring colleges to pay out a minimum proportion of their endowment funds -- has more than a little appeal. The diagnosed problem, as observers like Dean Zerbe of the Senate Finance Committee and the independent researcher Lynne Munson explained it at the American Enterprise Institute Friday, is that super-wealthy universities are doing too little with their riches to help students (especially low-income ones) afford college, continuing all the while to raise tuitions faster than inflation.

Their proposed solution -- forcing institutions with the largest financial endowments to pay out at least 5 percent of those funds a year -- would, they argue, compel the institutions to spend more of their own funds, ideally in ways that would make it possible for more students with financial need to enroll and succeed. Zerbe's boss, Sen. Charles Grassley of Iowa, is clearly enamored of the idea, and just last week he and the chairman of the Senate Finance Committee, Sen. Max Baucus (D-Mont.), sent letters to 136 colleges with endowments of at least $500 million asking a slew of questions about their endowment, financial aid and other practices.

But while the American Enterprise Institute session might have been seen as a coming-out party for the 5-percent payout idea, Friday morning's discussion was perhaps more notable for how much cold water got splashed on the concept. Some of the opposition came from expected sources: Terry W. Hartle, the lead lobbyist for higher education's lead association, the American Council on Education, offered a dispassionate list of reasons why the minimum payout was flawed. But perhaps the most surprising challenge came from someone who college leaders rarely see as an ally: Charles Miller, who as chairman of Education Secretary Margaret Spellings' Commission on the Future of Higher Education regularly skewered colleges -- especially elite ones -- for their many flaws.

"I am unalterably opposed to any requirement by the federal government of a minimum endowment payout ratio or any other similiar intervention into payout or investment policy," Miller said at the start of his remarks Friday, to the clear surprise (and delight) of some college leaders in the audience. Their pleasure probably didn't last long, though, for while Miller's reservations about the 5-percent idea echoed some of the reasons college leaders have cited, his overarching point was that higher education -- and its "generally dysfunctional system of financing" -- has far bigger problems to deal with than the endowment payouts of a relative handful of wealthy institutions.

The AEI event, which was broadcast by C-Span and can be viewed here), was the most thorough airing for an idea that has kicked around Washington for some time. Private foundations have such a requirement already, and while college officials argue that foundations are expressly designed to spend their endowments, and colleges use theirs to support the institutions for the long haul, the idea of applying it to colleges is gaining currency as their endowment coffers swell. Last month, an annual survey by the National Association of College and University Business Officers showed that 76 college endowments now exceed $1 billion, up from 39 in 2004.

Zerbe, who as an aide to Grassley has quietly spearheaded the Finance Committee's inquiries into endowment spending and other aspects of nonprofit governance and finances in recent years, was unshackled to speak freely Friday because he is leaving his job this week. While acknowledging that university endowments might have a different purpose from foundation endowments, he argued that college funds have other attributes that make them worthy of special scrutiny, most notably the mammoth size of many of them. And unlike private foundations, which have "a set pot of money" and do not seek donations to expand it, colleges and universities "are constantly encouraging and getting significant amounts to add to their endowments," he said.

Colleges and universities also benefit from huge direct investment of federal funds, especially in the form of financial aid and research grants, and tax breaks (state and federal) that allow them to use tax-free bonds to build facilities and take in many kinds of revenues (including donations) without taxation to them or their donors.

"We are giving massive tax breaks now, and the argument seems to be that some day we'll have a nice banana tree and we'll get bananas from it," Zerbe said. "Are we forgoing spending that we might be making now" to help taxpayers and students today?

"I'm flabbergasted to hear all the handwringing" about the idea of having a payout," he added. "Thousands of foundations do it, and the world has not ended. The world has not collapsed."

Munson, a research fellow at the American Enterprise Institute and author of a forthcoming book tentatively titled Scrooge U., sought to combat other objections that college officials have raised to the idea of a minimum payout requirement. To the idea that educational institutions need to save the funds for a rainy day, Munson said, "decades of hoarding" have resulted in a situation such that "it would take a rainy day of biblical proportion to require significant tapping into these stockpiles." When institutions face budget difficulties, she said, they are "far more likely to cut educational expenditures than to tap into endowments."

Certain incentives encourage institutions to hold on to their wealth, she said. "There is a longstanding habit of just keeping the money in a pot and not touching it, and it is becoming this wonderful badge of honor that helps it earn a higher ranking in U.S. News & World Report and, perhaps, a higher bonus for the university president."

(In fact, while many critics of the U.S. News rankings say that they favor wealthy institutions, it is not for the reason Munson states. The rankings reward colleges that spend a lot of money on various areas, but no part of the rankings methodology is based on endowment size -- a college basing endowment spending decisions on U.S. News would actually increase its spend rate.)

Hartle, of the American Council on Education, offered a range of reasons why the idea of the requiring a minimum payout -- which he acknowledged had "undeniable appeal" -- might be more complicated than it seems. Many of the funds in university endowments are restricted for specific purposes, so requiring a minimum payout may not achieve the goals policy makers want; despite the boom of recent years, endowment funds "can go down," and universities need to protect themselves against downturns like the one that appears to be coming; and public universities (and their endowments) are "creatures of state governments," so Congress would need to dictate policy not to university administrators but to state officials.

Lastly, policy makers may be mistaken if they think that dictating endowment policy will necessarily produce changes in how colleges and universities spend their money and set tuition, Hartle said. He noted that "of the roughly 100 private colleges and universities" that would appear on a "watch list" that the pending renewal of the Higher Education Act would create to single out institutions that raise their tuitions too much, "just three" were among the 136 colleges that received letters from Grassley and Baucus because their endowments are large. "That raises the possibility that colleges with large endowments actually raise tuition more slowly than" their peers, and suggests that any policy that targets endowments "wouldn't necessarily promote lower tuitions."

Policy makers are accustomed to hearing people like Hartle explain why federal regulation of colleges is a bad idea. But Charles Miller is no higher ed lobbyist, so his dislike of the idea drew special attention. "It's just fundamentally not sound public policy for the federal government to directly intervene at this level of institutional management," the Texas businessman and former regent at the University of Texas, which itself has a mammoth endowment. And as someone who managed money for a living, he engaged in a long riff arguing that the government should not tie the hands of the trustees, administrators and, for public institutions, state officials who have fiduciary responsibility for balancing short-term and long-term needs of their institutions.

"What gives the federal government the right to, in Texas terms, put their cotton pickin' hands on our money?" Miller said, pulling out a T-shirt for the conference's organizer, Richard Vedder of Ohio University, that said: "Don't Mess With Texas."

Welcome as those words might have been to foes of a potential minimum payout requirement, they were surely less enamored of Miller's underlying reason for opposing the idea -- that it would distract policy makers from and do little to address the real problem: that "the financing structure of higher education is elitist and is contributing to socially elite classes of students and academics." He urged a "ground up, no sacred cows, overhaul of [the] financial aid and financing system" in higher education.

Miller was not alone in suggesting that there might be more effective ways of ensuring access to higher education for needy students and diminishing the imbalance between the haves and have-nots in higher education. Sandy Baum, the College Board and Skidmore College economist, noted that the recent financial aid changes made by Harvard and Yale (and inspired by the threat of the payout requirement) were directed not at the neediest students but at families earning as much as $180,000 to $200,000. (Hartle added that Harvard and Yale's changes could have the perverse effect of forcing less-wealthy institutions to redirect their own resources toward competing with the top institutions for middle- and upper-income students.) Were there other public policy moves, Baum wondered, that would prompt colleges to redirect funds to the neediest students?

Munson suggested that the wealthiest colleges might use their own money to replace the federal Pell Grant funds they now receive and pass on to students, which would "free up $300 million that could go to other students attending other schools." Miller suggested that federal research dollars might be reallocated to universities with smaller endowments, rather than going primarily to the "oligopoly" that receives the bulk of them now.

And Vedder questioned whether all contributions to endowments should be tax-exempt, suggesting that donors perhaps should be rewarded for donations that help students afford college but perhaps not receive tax breaks for helping wealthy institutions build fancy dormitories.

That sort of brainstorming suggested the truth of one point on which virtually all participants in the discussion agreed: "The good news is that endowment funds are now on the table for discussion," said Munson. "They are no longer locked in a treasure chest."