The Question of the Tax-Exempt University

The debate over whether institutions like the University of Pennsylvania should be tax exempt focuses far more on the economic than the civic role they play, writes Matthew Fernandez.

October 13, 2016
The University of Pennsylvania in Philadelphia

Interested in working for a university in the 21st century? Forget the Ph.D. -- work for an investment bank for a few years and you may just earn close to $14 million in 18 months for your “mediocre” performance, according to a recent Bloomberg article detailing the salary Harvard University paid its endowment chief.

This is only the latest provocation for the rising chorus of doubt about whether it still makes sense to think of America’s elite private universities as nonprofit institutions. Even in our polarized political climate, Democrats and Republicans increasingly agree that this is now a reasonable question. Elite universities are becoming targets of the same populist anger evident in our politics. We hear increasing calls for them to explain their relentlessly rising tuition, relatively small percentage of low-income students and low spending rates on endowment returns -- as well as for reviewing their tax-exempt status.

In Connecticut, the state Legislature is about to debate a bill that would tax properties owned by Yale University. Princeton University is currently embroiled in a lawsuit threatening to revoke its property-tax exemption. Even congressional Republicans, normally tax averse, have requested detailed financial information from private universities with endowments over $1 billion and have floated the idea of taxing some portion of their endowments’ revenue.

My alma mater, the University of Pennsylvania, is among the leading universities facing pressure from its local community. In thinking about the continuing transformation of universities from nonprofits into sites for stockpiling capital, Penn is a particularly instructive. It likes to remind people that it was founded by Benjamin Franklin. An entrepreneur turned scientist and statesman, Franklin stands as a kind of prophet and preview of the practical, scientific and -- Penn would say -- philanthropic character of the institution he founded.

Although Franklin himself never attended college, he, like many tech entrepreneurs today, was an educational reformer. He first outlined his ideas in a 1749 pamphlet modestly titled “Proposals Relating to the Education of Youth in Pennsylvania.” Until that time, colleges -- led by Harvard, Yale and Princeton -- were established mainly to train ministers. Their curricula centered on scriptural commentaries as well as the secular classics. But Franklin believed colleges should also train students in the “useful arts” of commerce, mechanics and agriculture. On its website, Penn lauds Franklin's “innovative” and “radical” approach to education, citing the pamphlet as one of its founding documents.

But there is more to the story. By this time in his career, Franklin was actively distancing himself from his lowly origins as a printer and was intent on becoming a “person of Leisure and publick Spirit.” He wanted to see Philadelphia, then the largest city in British North America, become a modern metropolis. Though we associate Franklin with Philadelphia, he had spent the first 17 years of his life in Boston, where what might be called his neo-Puritan upbringing left an indelible mark on his thinking.

In his autobiography, he mentions the college along with other civic projects, such as raising a city militia and building defensive fortifications. What each of those projects had in common is their design to protect and unify colonists against external dangers (such as Indian attacks and foreign invasions) and internal ones (like idleness and insurrection). John Winthrop, the spiritual founder of Boston, had imagined it as a “model of Christian charity” and a “city upon a hill,” by which he did not mean to suggest that class divisions of the sort he had experienced in Britain could be swept away in a flood of communal love. But he did believe that the strife, bitterness and social divisions of early modern London could be mitigated in Boston if the hearts of its citizens were properly framed and its civic institutions well designed.

Franklin wanted to Bostonize Philadelphia but with an important difference: Philadelphia’s civic institutions would not be focused around the church but the college. That a major city should have its own college was perhaps the most radical and innovative idea in the pamphlet. Unlike Harvard, Yale or Princeton, the College of Philadelphia -- Penn’s original name -- came into existence explicitly to serve the needs of a city rather than a religious community. That was one reason it made sense for Franklin to design a more practical curriculum for the new college. Although technically a private institution, the College of Philadelphia was, in its civic orientation, arguably a forerunner of the modern idea of a public university as an institution dedicated to serve the local citizenry. Indeed, in addition to the college, the institution also operated a tuition-free “charitable school” that educated young Philadelphians who could not afford to pay for its preparatory school, the Academy of Philadelphia.

Today, relations between Penn and Philadelphia are not as amicable as Franklin had hoped they would be. About a year ago, Philadelphia’s City Council passed a resolution calling upon Michael Nutter, then the mayor, to demand payments in lieu of property taxes (PILOTs). And last November, the city elected Jim Kenney on a platform that included demanding payments from Penn. The university owns 299 acres in West Philadelphia, across the river from one of the nation’s most densely populated areas outside New York City. Kenney has yet to follow up on this promise. With the exception of Columbia University, Penn is the only Ivy League institution that does not such make payments (although Harvard has received criticism for paying less than the city of Cambridge requested).

What is most striking about the ongoing PILOT debate is that Franklin’s idea of the civic role of higher education has been all but lost in the discussion. The popular discourse surrounding PILOTs revolves around whether Penn is “paying its fair share” or not. Penn defends itself primarily by emphasizing the economic benefits it confers to the city. In addition to adding jobs to the local economy, the university also cites its $2 million annual contribution to the University City District, a nonprofit co-founded by Penn that provides services like street cleaning and trash removal to the neighborhood. Penn also runs the Netter Center for Community Partnerships, the main purpose of which is to give Penn students an opportunity to volunteer in West Philadelphia.

Rarely, however do either PILOT proponents or university administrators invoke Penn’s original civic mission, despite the fact that this is the only reason it is tax-exempt in the first place.

The Pennsylvania Constitution states that only “institutions of purely public charity” are exempt from paying state and local taxes. A 1985 ruling (Hospital Utilization Project v. Commonwealth of Pennsylvania) by the state’s Supreme Court established criteria known as the HUP Test for qualifying as a purely public charity, and the language of the test threatened the tax-exempt status of many nonprofits in the state. Facing legal pressure from City Hall, Penn agreed to a five-year PILOT program and contributed $1.93 million annually to Philadelphia. The PILOT program was not renewed, however, partly because of a 1997 state law that listed postsecondary education as an eligible “charitable purpose” and said that offering need-based financial aid counts as “donating or rendering gratuitously a substantial portion of its services.” Penn was no longer in danger of losing its tax-exempt status.

More recently, the state’s Supreme Court has again challenged the legislature, arguing that judicial branch, not the legislative, should decide tax-exempt status. This case has jeopardized the tax-exempt status of many nonprofits in Pennsylvania, including Penn. The state Senate proposed a constitutional amendment in 2013 that would have granted the legislature authority over defining an institution of purely public charity. Amending the Pennsylvania constitution requires a majority vote in both chambers during successive legislative sessions, followed by a statewide referendum. Although the state Senate approved the bill twice, the state House of Representatives did not vote a second time on the bill.

Whether a college was a charity or not would have been an unusual question 200 or even 100 years ago. Until relatively recently, even those universities that became known as “elite” were small and modest institutions as measured by their budgets and investments. Until Penn moved to West Philadelphia in the late 1800s, it never consisted of more than a couple of buildings, a handful of instructors and a few hundred students.

Since state-funded colleges were scarce until after the Civil War, institutions like Penn fulfilled a vital role in educating the young residents of the surrounding city. Penn did not build any student dormitories until 1895 partly because its trustees believed the university should cater primarily to Philadelphians. An anonymous letter published in The Nation in 1885 noted that it was university “policy” to instill its students with “Philadelphia doctrines, ideas, atmosphere and surroundings.” Even after dorms were constructed, Penn drew mostly from Philadelphia and the surrounding region.

The advent of the modern research university significantly altered the relationship between cities and higher education, and Penn was no exception. Rather than acting as transmitters of knowledge, institutions like Penn began to style themselves primarily as producers of knowledge during the course of the 20th century. The trend intensified during World War II when the federal government began pouring money into universities for military research. In 1946, Penn researchers brought the university into the international spotlight when they developed ENIAC, a computer designed to aid artillery calculations for the U.S. Army now regarded as the first modern electronic computer.

Universities across the country prioritized projects like ENIAC, often at the expense of undergraduate education. As one 1957 report frankly admitted, Penn needed to “eliminate or assign lower-priority status to educational functions which lie outside areas of strategic importance.” Penn no longer existed merely to educate young Philadelphians, and indeed, the city came to be seen increasingly as a liability. Unlike a university such as Stanford, Penn lacked open space and was surrounded by dense urban development. Projects like ENIAC required space, but West Philadelphia was no longer a sleepy, streetcar suburb. Worse, as Penn expanded in the 20th century, Philadelphia began to crumble under the pressure of deindustrialization and white flight.

Some trustees and donors contemplated moving all or at least part of the campus outside the city to the nearby suburb of Valley Forge, but the university opted instead to make the best of its urban location. Penn and other local universities joined together to form the West Philadelphia Corporation, aimed at gentrifying the neighborhood now known, tellingly, as University City. Besides improving local schools, the WPC also took more controversial actions, such as helping coordinate the razing of Black Bottom, a predominantly black neighborhood adjacent to campus. The incident significantly damaged the university’s reputation in West Philadelphia, and the tension continues today. (Locals refer to the gentrification of West Philadelphia as “Penntrification”).

Universities have changed from within, too. In the Victorian era, colleges were thought of as refuges from the worldly commercialism of cities. Urban universities tended to relocate to the outskirts of their rapidly expanding cities, as Columbia did in the 1890s with its removal to Morningside Heights, where, it was thought, the pastoral and insular character of universities could be better maintained. The poet Henry Wadsworth Longfellow, a Harvard professor, contrasted the “sweet serenity of books” with the “market-place” and its “eager love of gain … whose end is pain.”

Today, the realities of the marketplace seem to be sweeping away the sweet serenity. At elite universities in particular, numbers of humanities majors have been declining. Students understandably gravitate toward majors like economics and computer science, which many employers prefer, despite their often-stated preference for “well-rounded” and “creative” applicants. As colleges shift their attention away from general education and toward career preparation, the cloistered environment that the university once provided is becoming less attractive. Urban campuses provide students with networking and internship opportunities that are beyond the reach of rural colleges, especially those below the elite level.

The relationship between universities and their home cities has increasingly become interdependent as the economies of Rust Belt cities have shifted from a manufacturing economy to “eds and meds.” (Pittsburgh is a leading example.) Deindustrialization, along with increasing privatization, has transformed the image of universities not just into producers of knowledge, but most importantly, producers of wealth.

Today, universities provide private companies not only with new, profitable technologies, but also with a carefully vetted pool of laborers tailored to the needs of a global knowledge economy. The rest of the city exists mainly to cater to the consumer needs of this new professional class. In May 2014, the Brookings Institution released a report on “innovation districts,” using University City as one successful case study. The authors argued that innovation districts, which are mixed-use, urban areas anchored by large research institutions, will play an increasing role in generating economic growth in the years to come.

But the wealth generated by universities like Penn is distributed more asymmetrically than the manufacturing base it replaced. Innovation districts tend to be self-contained spaces where technocrats can work and then mingle with other technocrats over craft beer or pour-over coffee. As every Philadelphian knows, the divide between University City and the neighborhoods that make up the majority of the city is stark. Of course, universities were never designed to anchor an entire city’s economy. Many in Philadelphia find themselves both reliant on the economic benefits that Penn confers and aware that its interests do not always align with the city’s.

In this context, the PILOT debate in Philadelphia, along with calls for compulsory endowment spending and ending university tax exemptions elsewhere, should come as no surprise. They reflect a cultural transformation by which all aspects of American life seem to be increasingly, if not exclusively, assessed in terms of their economic value. Even critics of this transformation often frame their critique only in economic terms. Those on either side of these debates would do well to remember that Franklin, our first educational entrepreneur, imagined American higher education as a civic enterprise designed to promote citizenship, not economic growth.


Matthew Fernandez is a Ph.D. student in American literature at Columbia University and received his undergraduate degree at the University of Pennsylvania.


Back to Top