Policy Perspective

The College Affordability Crisis and Endowments
by Burton Weisbrod, Evelyn Asch, and Jeffrey Ballou

Fall 2008, Volume 30, Number 2

Not only are Americans faced with the most severe global financial crisis since the Great Depression, they are also faced with a college affordability crisis. With shrinking home values, 401(k)s, and 529 plans, Americans are more worried than ever about how they will pay for their children’s college education. During the campaign, both presidential candidates addressed the importance of ensuring college affordability for future generations.

These concerns about college affordability and rapidly rising costs have focused attention on fat university endowments. For the past 10 years, tuition and fees have risen annually 5.6 percent at private and 7.1 percent at public four-year universities. This rate has outpaced the inflation rate for consumer prices, which averaged just 2.7 percent per year. At the same time, student debt loads jumped 58 percent after inflation.

Lawmakers are all too aware of the political ramifications of rising tuition. In January, the Senate Finance Committee sent a lengthy questionnaire to the 136 American schools with endowments that top $500 million. According to Sen. Charles Grassley (R-Iowa), “Something’s not right when tuition heads sky-high alongside college endowment funds. In fact, billion-dollar, tax-free endowments should help mean affordable education for more students rather than only a security blanket for colleges.”

On September 8, Sen. Grassley and Rep. Peter Welch (D-Vt.) took a further step and convened a Capitol Hill roundtable on college endowments. This meeting was most likely the beginning of a move to regulate how colleges spend their endowments. This is a dangerous direction to go.

Our research into the relationship between universities’ activities and their missions shows that while it would be easy to mandate minimum payouts from college and university endowments, it would be exceedingly difficult to ensure that such a mandate translates into a more affordable undergraduate degree. We acknowledge the government’s right—and responsibility—to examine whether nonprofit schools are providing socially valuable benefits that justify their favorable tax treatment; however, we also believe that the politically popular call for mandating minimum payout rates is a dangerous solution—one that is likely to do more harm than good. We have laid out a number of reasons for this.

First, a mandate applied simply to “large” endowments targets the wrong institutions. Endowments are meant to ensure a school’s future viability in the face of adverse financial circumstances. When ranked by the number of years a school could fund its current expenditures with endowment payouts alone, only two of the largest-endowment schools—Princeton at no. 4 and Harvard at no. 16—break into the top 20.

Second, mandated payouts would not necessarily translate into more aid for needy students. In an increasingly competitive marketplace, any new financial aid might flow to wealthier students as merit aid. Indeed, the extra payout might not fund financial aid at all, but rather administrators’ salaries or a new swimming pool. Preventing this would require even more federal oversight, with the government stipulating how a school can and cannot spend its endowment payout.

Third, endowment payouts are only one source of financing for universities. If schools are compelled to spend money that they prefer to save, they might seek to bolster those savings through other channels—spending more on fundraising or even reducing financial aid.

Fourth, mandated minimum payouts might lead to creative accounting that renames assets something other than an “endowment” so as to exclude them from payout regulation. Such an unintended consequence of regulation could result in overall lower payouts than exist now.

Fifth, targeting large endowments could affect at most a small percentage of undergraduates: The overwhelming majority of college students attend schools with endowments under $500 million. And with endowment earnings sharply down—wealthy little Grinnell College, for example, lost 12 percent in its total endowment in the last year—even fewer students will be possible beneficiaries.

It is appropriate for legislatures to consider when an endowment is “too large” and so should be either taxed or discouraged in some other way. Moreover, we applaud the legislators’ emphasis on increasing the affordability of higher education. Nevertheless, endowment regulation is not the solution.

Burton Weisbrod is John Evans Professor of Economics and an IPR faculty fellow. Evelyn Asch is an IPR research coordinator. Jeffrey Ballou is an economist at Mathematica Policy Research in Cambridge, Mass. Their book, Mission and Money: Understanding the University, was published by Cambridge University Press this fall.