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 greater than $1 billion. The proposal, if approved, would affect nine schools in the state, such as Harvard University, whose $34.9 billion endowment is the largest in the nation among educational institutions; Massachusetts Institute of Technology in Cambridge; Tufts University in Medford; and Wellesley College in Wellesley.

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 Tufts University.

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

Changing the investment strategy isn’t 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.”

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.”

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

Endowment managers say that the tax would harm their institutions.

If the proposal were approved, 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 school, which is in Cambridge. Donors would be less likely to contribute because part of their donation would have to be paid to the state in taxes, he said.

“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.

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.”

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

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.

Last year, returns of more than 700 endowments averaged 17%, Commonfund said.

“But in 2002, endowments lost an average of 6%,” Mr. Jarvis said. “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.”

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

“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,” he said.

E-mail Sue Asci at [email protected].