Republicans in Congress are hoping to use the budget reconciliation process to increase the existing endowment tax on very wealthy private colleges and universities. It’s a bad plan, and the best thing Congress could do to the endowment tax this week is eliminate it altogether. That’s not going to happen, however, not when the only thing the GOP is hotter to do than humiliate elite colleges is find revenue for President Trump’s tax cuts. Congress could, however, easily make the endowment tax not only do less harm but even accomplish some good.
Supposedly, doing some good was the aim when Republicans used the budget reconciliation process in 2017 to create a 1.4% tax on investment growth at private universities. Kevin Brady, chair of the Ways and Means Committee, claimed, “The goal is pretty simple: It encourages colleges to use their major endowments to lower the cost of education.” It was never clear how the endowment tax would lower the cost of college.
Beyond the donor restrictions that make it difficult, albeit not impossible, to use donations for unintended purposes, it was far-fetched that somewhere like Princeton, with an endowment worth more than $2 million per student, was ever going to spend enough to get out of the tax. Enrolling more students to get the endowment value per student down was just as absurd, given the size of the endowments. Harvard is one of the hundred largest universities in the nation, but it would need to increase its enrollment by 70,000 students to get below the tax threshold. Increasing enrollment is a good idea, particularly at rich colleges that care too much about their admit rates, but it also takes a lot of time, housing, hiring, and money to accommodate even a fairly small number of new students. It is also a myth that highly selective colleges have not expanded enrollment over the past few decades.
What’s more, many of the colleges and universities subject to the tax already meet the full financial need of their students. A low- or middle-income student who manages to get admitted to an Ivy League school will almost certainly pay less to go there than to their state flagship.The reality is that the endowment tax was from the start a small-minded gesture, created out of spite rather than an interest in access to opportunity, with an equally small impact. It brings in relatively little revenue–about $380 million from 56 institutions in 2023–which vanishes into the vast federal coffers and even vaster fund of Republican resentment.
Financial aid, in fact, is the largest recipient of endowment spending. Two-thirds of university endowments are used to fund student financial aid and academic research. That’s why the current endowment tax is not smart. It takes money away from the good things colleges and universities do. A smart endowment tax would create incentives to do more good.
Higher education associations have long insisted that the endowment tax mainly hurts poor students, but there’s a problem with that argument. While it’s true that someone from a low-income household who gets admitted to an Ivy League school will almost certainly pay less to go there than to their state flagship, it’s also true that most of the people who go to megarich colleges are themselves rich. According to the research group Opportunity Insights, a student from a high-income family is more than twice as likely to be admitted to a college like Dartmouth or Stanford than someone with comparable SAT scores from low- or middle-income family is. That rich kid advantage comes from legacy preferences, athletic recruiting, and attending expensive private high schools. So, yes, the colleges subject to the endowment are in fact quite affordable for low-income students. They are not, however, all that accessible.
The endowment tax represents a way for Congress and rich institutions to put their money where their mouth is. The tax should be amended to ensure that no harm is done to low-income students. It should also be used as a lever to increase social mobility by rewarding these institutions with lower tax rates if they take these steps to open their campuses to qualified students from all walks of life, not just the most privileged.
Here are five ways to tax endowments properly:
1. Deduct spending on public goods.
Colleges and universities should be allowed to deduct whatever they spend on need-based financial aid for students and research. These deductions could provide an incentive to spend more, not less, on access and innovation, which benefit all Americans.
2. Reward colleges that do not provide legacy preferences.
Three out of four Americans oppose the practice of providing an admissions advantage to the children of alumni, and more than 450 colleges and universities have dropped legacy preferences since 2015. Less than a quarter of four-year colleges now consider legacy status, but 58% of the colleges likely to be subject to the House version of the endowment tax continue to offer this birthright privilege to the students who least need it. These rich schools are afraid that dropping legacy admissions could hurt donations, but providing a 10% cut to the tax rate to institutions that do not provide a legacy preference could erase that fear and help level the playing field in admissions.
3. Reward institutions for enrolling more students eligible for federal aid.
Almost a third of all undergraduates in the United States receive a need-based Pell Grant from Federal Student Aid, but at the institutions subject to the endowment tax, just 17% do on average. If colleges received a larger reduction in their endowment tax rate as they increased their share of undergraduates who are Pell-eligible from a minimum of one in five up to one in three, the savings on the excise tax would help pay for the added enrollment expense and make these colleges look more like the rest of the country and less like a country club.
4. Reward institutions that enroll a significant number of transfers from community colleges.
Bad as their record is on the enrollment of low- and middle-income students, most elite colleges are even worse when it comes to enrolling transfer students from community colleges. Princeton, for instance, went twenty-five years without admitting a single transfer. In 2023, the sixty-six colleges and universities who may be subject to the endowment tax enrolled about 4,500 transfer students combined. That is about 300 more transfers than the University of Houston enrolled and 2000 less than the University of Central Florida did, by themselves.
Congress should incentivize wealthy colleges to enroll more community college transfers by reducing their tax rate by the same percentage as the share of new enrollments that come from community colleges each year, so, for example, if eight percent of the new students enrolled in a year were community college transfers, that institution’s tax rate would be reduced by eight percent.
5. Use the revenue from the endowment tax to support the institutions that are already serving as social mobility engines.
The House version of the endowment tax will raise $6 billion over the next decade. That sounds like a lot of money until you put it against the three to four billion dollars that the House reconciliation budget is predicted to add to the deficit. The Senate version will raise less than a billion dollars over ten years. It makes much more sense to take the revenue collected by the endowment tax to support the Postsecondary Student Success Grant program, which provides direct funding to institutions that enroll high percentages of Pell-eligible students and graduate them at higher rates.
The endowment tax began as a small-minded gesture with an equally small impact on the federal budget, but simply making it bigger and badder is not the answer. The Senate should make the endowment tax better so it helps all Americans.
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