Do you think some colleges are "hoarding" their endowments?

(cross-posted from BlogHer)

On Thursday, the commissioner of the Internal Revenue Service's tax-exempt division told an audience at Georgetown University that the IRS would be looking into how colleges and universities spend (or don't spend) their endowments. (You can download his remarks here as a PDF.) Senator Charles Grassley (R - Iowa) and others have called for an investigation--and potentially regulation--of endowment spending by U.S. colleges and universities. Representative Peter Welch (D - Vermont) also amended HR 4137, a reauthorization of the Higher Education Act as the "College Opportunity and Affordability Act of 2007," to require "annual reporting by colleges and universities on how much of their endowment was paid out each year for the purpose of containing college costs." Welch also had proposed, but withdrew in February, an amendment that would have required colleges to withdraw at least 5 percent of their endowment each year and to use those funds to contain the cost of college for students.

But what is an endowment, exactly? Concordia University Wisconsin describes it thus:

An endowment is an amount of money (fund) that is given to the University with a stipulation that the funds are invested to earn annual interest rather than spent immediately.

The University of New Hampshire Foundation elaborates, telling us that an endowment is:

a permanent source of income for University programs and/or departments. Gifts to an endowment are invested, with a percentage (currently 3.8%) of the income growth supporting a specific University purpose as directed by the donor(s). The remaining income (minus an administrative fee) is reinvested into the endowment, ensuring that the value of the investment grows forever.

In an ideal world, then, a college or university would grow its endowment through alumni and others' donations, as well as through strategic investments, and "live" off of a portion of the interest earned on that sum of money. You can imagine why it would be controversial in some circles to suggest that all colleges and universities withdraw from their endowments at a rate of 5 percent each year--especially at a time when many investments aren't offering a 5 percent rate of return. At the same time, some endowments are exceptionally large--Harvard's, the largest academic endowment in the world, sits at $34.9 billion--so it's pretty easy to level charges of "endowment hoarding."

In what may be a sign of a desire to regulate themselves rather than have Congress regulate them, wealthy colleges and universities across the nation are offering more generous financial aid packages, including some that entirely replace student loans with grants. This group includes liberal arts colleges--Williams, Swarthmore, Davidson, and Grinnell, for example--as well as universities such as Princeton and Stanford.

Daniel Brooks, a professor of supply-chain management at the W. P. Carey School of Business at Arizona State University, raises the issue of universities' tax-exempt status, comparing their spending to that of other nonprofit foundations:

Non-university foundations are required to spend at least 5% of their total value each year to retain their tax-exempt status. At issue is whether there should be a 'required payout' for university endowments, as well. These can be sizable amounts -- for Harvard, that would mean an annual payout approaching $2 billion. The universities with the largest endowments are spending less than the 5% per year required of non-university foundations. Some parents of students at some of these schools have asked why tuition remains so high if the endowments have, over the past decade of investment, created such wealth for the universities.

How does one spend an additional $2 billion a year? Based on my search for women bloggers writing on this issue, endowment spending doesn't seem to be a major concern of bloghers--or at least one that they feel qualified to comment upon. One notable exception: Margaret Soltan, an English professor at George Washington University, has written extensively on the subject at University Diaries, particularly regarding Harvard's endowment. In one post, she writes,

It's particularly disgusting for universities, centers of free thought about the values, insights, and behaviors that matter most to a culture, to represent grasping money-making machines, as Harvard does to more and more people. The striking thing about Harvard University, the talked-about thing, the thing much more notable than its professors and its libraries (which, as Tim points out, aren't as impressive as you might think given all that cash), is a degree of wealth unmatched by many nations of the world. What sort of power fantasy is Harvard playing here? Why has it, in gaining wealth obscenely disproportionate to any other institution of higher learning in the world, and obscenely disproportionate to anything that Harvard University might need to maintain and improve itself, removed itself from the fellowship of universities?

Soltain is responding in part to a blog post in which Timothy Burke argues that driving down tuition costs may end up hurting a college's reputation. Burke writes,

It sounds very appealing in some respects to make attending completely free, but two things to consider. First, what’s the argument for making it free to wealthy families? That doesn’t serve a social justice objective. Even in a very well-endowed institution, there is a sizeable per-student cost. If it isn’t defrayed by tuition, it’s paid from endowment income, and that payment deprives the institution of other opportunities to use those funds elsewhere.

Second, there’s a lot of evidence out there that lowering the sticker price of selective higher education has a perverse impact on the quality of applicants, e.g., that parents are using high prices as an informational signal of quality.

I heard a similar argument last fall at an alumni gathering at my own alma mater, Grinnell College. When it became clear during a question-and-answer session with the college's president and development director that the college could probably afford not to charge any tuition at all, some alumni expressed reservations about free tuition at Grinnell. After all, in my experience, Grinnell is kind of a quirky place, and it draws a particular kind of student--the kind who is perfectly OK with living in the middle of Iowa, in a town of 8,000 or 9,000 people, on a college campus of 1,500 students, where the nearest "big city" is Des Moines, 50 miles away. Offering free tuition to all students, regardless of financial need, might draw students seeking a free education rather than a Grinnell education. (As it stands, Grinnell recently decided that no student will graduate from the institution with more than $8,000 in loans.)

A New America Foundation blog post on education policy argues that requiring wealthy colleges to reduce their tuition through need-based, rather than merit-based, aid would benefit those students who most need the assistance:

How then do charitable institutions of higher education justify the practice of increasing spending on merit aid at the expense of need-based financial aid on their campuses? The strategy, which has quite a number of adherents, essentially seeks to raise or maintain institutions’ status by buying well-credentialed students who don’t need the money. Funds that could help academically-qualified poor kids to enroll in good schools are instead being used to entice affluent students with fat GPAs and high SAT scores, the raw material (along with endowment figures, graduation rates, and other quantifiable factors) upon which institutional status is built.

The disparity is made worse at a time when students from low-income families -- one of the fastest growing segments of college-age young people -- are finding it increasingly difficult to afford college at all. Many of those financially-needy students who make it to college are being forced to take on unmanageable levels of debt, including higher-priced private loans, as a result of these policies.

Would it serve the public good to compel wealthy colleges to spend a minimum percentage of their endowments each year? We think so. Currently, 62 colleges have endowments of at least $1-billion and they control the vast majority of higher education endowment assets, according to the National Association of College and University Business Officers. Perhaps the lawmakers should focus the proposal on those institutions and any others that eventually reach the $1-billion mark -- that way they can't possibly be accused of endangering colleges that are anywhere near the financial brink.

I've heard this question raised a number of different ways over the past 20 years: Should students be rewarded (with merit-based aid) for superior academic records, athleticism, and extracurricular excellence during high school, even if their parents already have the ability to pay all or part of their tuition? Or should colleges focus more on need-based aid to students who may exhibit academic or extracurricular excellence, but maybe not as strongly or across the board as students in the first group? Unfortunately, too often the responses to these questions degenerate into a debate about affirmative action because some people imagine those in the first group of students to be white, and those in the second group to be students of color. In reality, the color line is not so well-defined. But asking these questions does require us to venture down paths that might lead us to more uncomfortable questions, including whether we ought to provide tuition remission, as well as a different set of admissions standards, for students who attended poorly funded high schools. If we are going to spend down an endowment in order to contain college costs, who should benefit? Should all students benefit equally from these funds?

There are other issues at play beyond less expensive tuition. A debate on the USA Today blog raises even more issues:

Given the rising tuitions, embracing the mandatory payouts is tempting. But for several reasons, that would be a mistake:

* Impracticality. The popular image of endowments as a big slush fund is inaccurate. Most college endowments are a compilation of hundreds or even thousands of gifts, many restricted by the donors for specific purposes, such as the arts or sciences. A federal mandate to pry open endowments is as likely to create more science labs as student scholarships.

* Academic freedom. Congress stepping in to dictate how schools should handle their endowments is akin to telling them how to recruit freshmen classes.

* Future responsibilities. College officials refer to this as "intergenerational equity," which means not spending down what might be needed in the future.

That said, Fay at Historical/Present suggests a critique of the "intergenerational equity" that college boards of trustees are charged with building may be in order.

Lynne Munson of the Center for College Affordability and Productivity published an editorial in Inside Higher Ed. I'm going to quote at length because she sums up nicely many of the arguments for regular spending of endowment funds:

A recent survey of 765 colleges and universities found they are spending 4.2 percent of their endowments’ value each year. Meanwhile, private foundations — which are legally required to spend at least 5 percent of their value annually — average 7 percent spending.

Higher education endowments differ from private foundations in one particularly important respect. Private foundations exist to give their money to others, while college and university endowments support just one charity — their school. But isn’t being your own sole beneficiary reason to spend more, not less? Particularly when a substantial area of spending — financial aid grants to current students — targets precisely the people you expect will be your future donors?

Paradoxically, it is precisely the meager financial aid outlays of endowment-rich colleges and universities that make the true miserliness of low payout practices most apparent. Stanford University spends $76 million on undergraduate financial aid, a sum that sounds generous but amounts to a mere 0.5 percent of the value of its endowment. The university spends just 4 percent of its $14 billion endowment toward operating expenses. If the 5 percent payout rule required Stanford to spend another 1 percent of its endowment, and that money was directed toward financial aid, students would enjoy $211 million in additional support. That is precisely the cost of letting all 6,600 Stanford undergraduates attend tuition-free.

The University of Texas’ nine campuses enroll 147,576 undergraduates who each pay on average $5,903 in tuition. All of U.T.’s undergraduates could attend school tuition-free if the system spent half the amount the university’s endowment grew just last year.

Of course just because a college can afford to offer education tuition-free doesn’t mean it should. Giving a free ride to students who can afford to pay obviously would cut into the bottom line in other ways. Also, education is a real service for which people should pay. And a higher quality education should command a steeper price.

But college and university endowment spending practices should reflect the public responsibility that adjoins tax-free status. When people donate to a school they get a tax break because their donation is supposed to serve the public. When those untaxed funds sit unused, piling up for decades, taxpayers are making a sacrifice and getting nothing in return.

What are your thoughts?