Thursday, November 09, 2017

Political Campaigns and the Future of the University

Joseph Fishkin

It’s no secret that the Republican tax plan is something of an innovation in legislative partiality—the favoring of some sectors of the country and the economy over others. Some parts of the bill add complexity and others reduce it; some parts raise revenue and others destroy it; but it’s difficult to find a provision in the sprawling (and still-evolving) bill that doesn’t favor relatively Republican constituencies—such as the very wealthy with large estates, or recipients of large amounts of “pass-through” business income—over relatively Democratic constituencies, such as people with lots of education and student loans, or upper middle-class residents of expensive coastal cities who deduct a lot of state and local taxes and mortgage interest. It didn’t have to be this way: when you’re planning to blow up the deficit by $1.5 trillion, there’s ample room to cut everyone’s taxes a little, while still cutting your favored constituencies’ taxes a lot. This bill goes a different way: some people’s taxes are definitely going up to pay for others’ taxes going even further down, and the bill writers seem pretty clear about who they favor and disfavor. The bill’s myriad higher education provisions are a good example. The House bill doesn’t just kill the important above-the-line student loan interest deduction. It also, as described in media reports, would require all universities that waive tuition for graduate students to treat such tuition waivers as income to the graduate students, on which the students would then owe tax. The bill would eliminate or restructure multiple tax credits that help non-traditional and part-time students pay tuition; it would eliminate the tax subsidy for employers who pay their employees’ educational costs. At elite schools, the bill would kill the tax exclusion for tuition benefits for faculty members’ children; it would introduce a 20% excise tax on compensation over $1 million (for the top employees of any nonprofit, including colleges, although for-profit colleges would be exempt)*; and finally, as has been widely reported, it would impose a 1.4% annual tax on the earnings of large university endowments.

In light of the approach to tax legislation that this bill exemplifies—rewarding favored constituencies and punishing disfavored ones—and in light of the evolving self-conception of the Republican party, some sort of attack on large university endowments, which would once have been politically unthinkable, instead now begins to seem politically inevitable. Taxing these endowments strikes at the heart of the educational elite that some Republicans, unfortunately, have come to see as sitting at or near the center of what they’re fighting against. And these endowments are big enough that taxing them could generate real revenue. To be sure, the tax proposal in the current (House) bill is pretty modest. In round numbers, a $700 million endowment, that generates $70 million in income this year, would have to pay $1 million in tax. That’s real money that will have to come from somewhere, but it’s not going to radically change the nature of the university. However, if one of our political parties continues to view elite universities the way the current Republican party does**, the political logic of further raising taxes on elite-school endowments to defray future revenue needs could be irresistible. (And indeed the current proposal, if enacted, would over time increase its bite: it applies only to the largest endowments as measured on a per-student basis, but the threshold where the tax kicks in is not indexed to inflation, so each year a few more schools will get caught in its net.)

To me, the interesting question is how higher education itself would be reshaped by these changes in tax policy over the long term. And there – particularly when it comes to the innovation of taxing large private-school endowments – I wonder whether a (potentially disturbing) lesson might be drawn from the evolution of political campaigns and parties in response to changes in campaign finance rules.

Here’s the thought. Universities today have a range of revenue streams: tuition (including student loans), government support, and donations from alumni and other generous people. We might divide the last stream into small and large donations. This bill takes aim, directly or indirectly, at each stream. The doubling of the standard deduction would mean that far fewer people would get any tax benefit from making a donation; this would somewhat reduce the incentive for small donations (to universities and all other 501(c)(3)s). Killing the estate tax would significantly reduce the incentive for large donations. However, I have no doubt that a lot of people with millions of dollars will continue to believe that supporting universities is a good use of their money. The question is how—and here the new tax bill alters the incentives in a subtle way.

Under either current law or this new proposed law, donors have two basic choices. Option One: Give a donation directly to your school, whereupon it becomes part of the school’s endowment. Option Two: Keep the money someplace else—in some sort of entity outside the university’s endowment. Your heirs or other trusted people manage the money and use it for the benefit of the university over time. With Option Two, you have a degree of influence and control that is practically impossible if the university itself holds the money.

The current Republican tax bill is introducing a tax on Option One. If you put the money directly into the university endowment, its income will now be taxed at 1.4% or whatever rate a future Congress sets. (Donors think long-term.) This would tend to encourage donors to choose Option Two. Now at this point the tax story gets a little complicated. The most traditional vehicles one might use to pursue Option Two are also subject to a net investment tax similar to the one now proposed for the big university endowments. But two very smart tax colleagues of mine tell me that these days, this tax is easy for donors to avoid, by varying the form they would use to pursue Option Two (for instance, a donor-advised fund does not owe the tax). I’ll be the first to admit that at this point we are at, or maybe beyond, the frontier of my knowledge of tax law.*** So let’s simply assume the following: that this still-evolving bill or some future Republican tax bill will on the whole cause Option One to receive less favorable tax treatment than it does now, making Option Two relatively more attractive than it is now. Tax is not the only difference between the options, of course. Option One offers the key advantage—which universities will no doubt emphasize—that university endowments often earn really good returns. Meanwhile, Option Two offers an extra degree of power and control, which I suspect some donors will find attractive when the option is squarely presented. In the end, an endowment tax will likely cause relatively more donors, over time, to choose some version of Option Two. But why should we care about this? Does this matter?

In the long run, it could matter a lot. If, over time, more donors choose Option Two, this will lead to a subtle shift over time in the locus of control of university funds: away from academic leaders, and toward the owners and trustees of large foundations and independent endowments, whose interaction with the university would extend into a more ongoing and complex relationship. Speaking broadly, some of the decisions now made inside universities about how to use endowment funds donated long ago would instead come to be made in ongoing negotiation with “outside” entities that control streams of the university’s annual revenue, which may have their own visions of the university’s priorities and future. To an extent, this already happens; but taxing large endowments could lead to much more of it.  (And although the contours of such rules are hard to predict, an endowment tax will almost inevitably lead to anti-circumvention rules that will require outside entities to show that they are actually independent of the university endowment, rather than independent in name only, if they want to avoid the tax.)

There is a parallel here to what has happened to American political parties and campaigns in recent decades, as Heather Gerken and I have described elsewhere. Donors have always had considerable influence within the broad coalitions we call political parties. But in part because of changes in campaign finance law, more of the functions of traditional campaigns and political parties are now being performed by entities outside the official parties and campaigns—“shadow parties” that answer exclusively to their donors. The effort to elect Ted Cruz President, for example, involved not only the actual Ted Cruz for President campaign, but three (eventually six) different shadow campaign groups, the first three of whom were all named some variation on “Keep the Promise” but each of which was beholden to a different eight-figure donor, who gave the money and had final control over strategic decisions. One group ran the television ads, another focused on digital targeting, and a third organized and held campaign rallies where the actual candidate, Cruz, appeared as a special guest. None of this was directly under the control of Cruz’s official campaign. As more and more of the functions of political parties as well as campaigns migrate to outside groups—even things as basic as keeping the voter file or organizing volunteers—control of the direction of the “party” shifts, with large donors gaining power relative to other constituencies, such as party activists. One can readily imagine a similar future restructuring of donations to universities. Different high-dollar donors can create their own parallel entities to aid the university without directly adding to its endowment. To the extent that these become more central to the functioning of the university, they slowly shift power toward one constituency: the donors.

I don’t want to be overly romantic here. University leaders always listen to donors. That is part of their job. But the role of a university leader, like the role of a politician, is more complex. Leaders answer to multiple constituencies. A university president must maintain the confidence of the faculty, students, and staff. A university president typically answers to a board that includes large donors, but embeds them in a larger structure of group decision-making and deliberation among members who are chosen for a range of reasons, not all of them exclusively because of the dollar amounts of their contributions to the school. It’s different with independent entities that keep hold of their endowment principal and use the proceeds to help the university on an annual basis (which could at any time be withdrawn). Unlike a university president, these entities do not need to worry about outraged students and faculty marching and picketing outside their home or office on campus. Like many of the new Super PACs and other outside groups reshaping American politics, they are structured to answer only to their donors. 

The stakes of the shift to shadow parties, as Heather and I understand them, are largely about this shift in the locus of power within the party, toward donors and away from party activists and other constituents. The stakes for universities could be similar. The endowment tax is a small step, but it could mark the start of a very consequential long-term unraveling, in which the locus of control within universities gradually shifts: away from the medieval idea of a self-governing faculty, away from the modern idea of shared governance by stakeholders including students, faculty, staff, and alumni, and toward the very-late-capitalist idea that ultimately, those who pay the piper are the only ones who can legitimately call the tune.

*I am actually ok with the over-$1-million-in-compensation tax, although I would rather extend it to for-profit firms, and indeed would even more prefer to simply put a surtax on all income over $1 million. However, the change in treatment of tuition waivers for struggling graduate students is just cruel.

**For an interesting response by a Republican whose party has clearly left him behind, see this op-ed by Princeton trustee George Will.

***A huge thank you to Calvin Johnson and Susie Morse.  All errors are definitely mine.

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