Massachusetts eyes endowment tax

A first-in-the-nation bid by Massachusetts legislators to tax large private-college endowments would result in less money for research and student financial aid, according to many institutions.

The proposal, submitted by state representative Paul Kujawski of Webster, would impose a 2.5% excise tax on educational endowments that exceeded $1 billion. The proposal, if approved, would affect nine institutions in the state, including Amherst College; Boston College; Harvard University, whose $34.9 billion endowment is the largest among the nation’s educational institutions; Massachusetts Institute of Technology; Smith College; Tufts University; Wellesley College; and Williams College.

The state House voted 136-18 to table the amendment and move the proposal to the Department of Revenue for study.

“[The bill] would cut spending in half,” said Thomas McGurty, vice president of finance and treasurer at Medford-based Tufts University.

Tufts assumes a 9% long-term return on its $1.5 billion endowment. It spends around 5% of fund assets annually and reinvests 4%, Mr. McGurty said.

Changing the investment strategy is not likely.

COMFORT FACTOR

“We’ve already made decisions and are comfortable with our risk/reward profile in our portfolio,” Mr. McGurty said. “To think that we could change our asset allocation to grow that 9% to 11.5% … any chief investment officer would be very leery of that. You would be taking on a lot more risk and a lot of volatility, and that is not to say that you will be able to execute that level and generate those returns.”

Facing a $1.3 billion state budget deficit, “the tax proposal was introduced to raise revenue,” said Mr. Kujawski, who is a member of the House Ways and Means committee.

“Endowments are growing at a rapid pace,” he said. “It’s an effort to generate some revenue and improve the quality of life in the state. You cannot make me believe that the challenge of overcoming that 2.5% obstacle wouldn’t be met by the people running those funds.”

It is estimated that the tax would bring in from $1.4 million to $1.5 billion in the first year, Mr. Kujawski said.

Those managing endowments maintain the tax would harm their institutions.

If the proposal were to become law, Harvard’s endowment, for example, would be assessed about $840 million the first year, said Kevin Casey, associate vice president of government and public affairs at the Cambridge-based school.

Donors would be less likely to contribute because a portion of their donation would have to be paid to the state in taxes, he added.

“The tax will cause a downward spiral for all institutions above $1 billion and handicap our ability to raise additional money,” Mr. Casey said.

While investment returns have been good in recent years, the endowment lost money in 2001 and 2002, he said.

Wellesley College’s $1.7 billion endowment assumes a 5% to 5.5% real return annually and spends at a rate of about 5%, said Jane Mendillo, the endowment’s chief investment officer.

“If we achieve that real return, we’re about keeping even,” she said. “If you add 2.5% to that spending rate, you are not keeping even.”

In order to protect the endowment for the future, the institution must stay at the current spending rate. “If you add 2.5% to that, you are raising the effective payout by 50%,” Ms. Mendillo said. “That would be a significant squeeze on what the endowment could support over the long term.”

To increase the payout to 7.5% is “in excess of what any prudent endowment manager would allow,” Ms. Mendillo said. “I don’t know if there is any way to adapt to ensure that you could have that 7.5% payout annually and protect the endowment for inflation. It’s not an easy fix from the investment side.”

The college would have to consider cutting spending, which would affect financial aid, research and faculty salaries, Ms. Mendillo said.

WHAT WILL MANAGERS DO?

It is difficult to predict what endowment managers might do if the tax passes, said Bill Jarvis, managing director of the Commonfund Institute, the research arm of Commonfund, a Wilton, Conn.-based investment management firm that works with endowments and foundations.

In 2007, returns of more than 700 endowments averaged 17%, Commonfund said.

“But in 2002, endowments lost an average of 6%,” Mr. Jarvis said. “Everybody lost in 2001 and 2002. It is misleading to behave as if double-digit investment returns are going to be made every single year.”

Nevertheless, many cash-starved states may find endowments too tempting to overlook.

“Tax-exempt wealth in foundations or endowments might well be a target of legislative proposals,” said Paul Grogan, president and chief executive of The Boston Foundation, a private community foundation with $1 billion in assets.

The proposed tax is a symptom of not understanding the contributions of institutions of higher education, he said. “The idea that universities are somehow parasitic on Massachusetts and Boston is counter to the facts,” Mr. Grogan said. “They provide tens of thousands of highly paid jobs and are responsible for the formation of many companies. They also draw talent to the state.”

Mr. Kujawski acknowledges those benefits but still touts the tax.

“They are a big part of our economic engine. But while they are contributing to the economy, they could do a little more based on the fact that they have a [non-profit] entity and condition that most people, businesses and corporations that acquire wealth do not have.”

E-mail Sue Asci at [email protected].