Regulating College Endowments Is the Wrong Answer

By Dr. Michael A. MacDowell
Congressman Tom Reed of New York plans to introduce a bill in the House of Representatives that would require colleges and universities with endowments of over $1 billion to devote 25% of their annual endowment income to aid financially deserving students.  If they do not, these institutions would lose their tax exempt status.
His bill reflects what many believe to be true – that all colleges are rich and their tuition is too high.  The truth is that only about 100 of the nation’s colleges and universities have endowments approaching $1 billion.  Together these institutions represent just 2.5% of the nation’s 4,000+ private and public colleges and universities.
The vast majority of colleges and universities in this country have endowments of less than $25 million.  They adhere to endowment income utilization rates requiring them to use about 4% of their endowment.   Any income above 4% is returned to the endowment fund.  This policy assures that some funds for future financial aid and other purposes will be annually available even when markets are underperforming as they are now. The net result is that a $25 million endowment generates less than $1 million a year.
Further, many believe that all the income earned from an endowment can be expended in any way institutions choose. This is usually not the case.  Those who contribute to an institution and create an endowment often restrict the endowment’s earnings to certain projects and programs.  These are legally binding restrictions.  While some endowments are designated to be used for student scholarships or other financial aid, many are not. The result is that few colleges or universities can arbitrarily shift all their endowment earnings to student financial aid.
The result of these endowment realities is that the vast majority of American colleges and universities have far less endowment income than most believe they have. Despite this fact, the average private college/university awards financial aid to over 90% of its students. The total amount of scholarships and financial aid awarded each year far exceeds annual endowment income.
Some of the gap between endowment income and the amount colleges spend on financial aid is made up in annual gifts by alumni and others. But even these gifts, along with federal Pell grants and other government sponsored aid, does not cover all of the scholarships and financial aid private colleges are awarding.  Private colleges and universities make up the difference by discounting or lowering the price of tuition.
The discount rate at private colleges and universities has been increasing every year, especially since the Great Recession.  Some institutions’ discount rates exceed 50% of tuition costs.  The discounted tuition income cuts severely into revenue. As a result, colleges and universities have fewer dollars in subsequent years to pay faculty and staff and to carry on their basic operations.  That leads to charging higher tuition, which in turn generates higher discounts. This vicious cycle is getting worse each year. One result of this income shortfall is that 50 private, non-profit 4-year colleges and universities closed in the past 10 years.  More will no doubt do so in the near future.
Legislation like that proposed by Congressman Reed will have little if any impact on the vast majority of American college students because almost all colleges and universities already give well over 25% of their endowment income to student financial aid.  The problem is complex. Simply forcing the reallocation of endowment income of the nation’s richest universities is not the answer.  Instead of wasting the time of legislators on bills that address only perceived problems, Congress should focus upon legislation that would allow colleges to reduce costs and help the vast majority of students who will not attend the tiny percentage of institutions with $1 billion endowments.