Universities and Illegal Tax Arbitrage

Here's My latest post on the CCAP blog:

Iowa Senator Charles Grassley is perhaps the biggest critic of higher education in Congress, seeking out scandals and improprieties in the Ivory Tower in an effort to effect change. He has thus far failed to achieve any great and lasting reforms, but I give him an 'A' for effort and his willingness to travel the road often not taken - battling the establishment. So what's Chuck up to these days? His latest criticism of higher education is the use of tax-exempt bonds by universities for (indirect) tax arbitrage. In other words, Grassley believes that universities are taking advantage of their non-profit status to raise cheap, subsidized capital that they use to bankroll higher risk investments and capital expenditures. So what is the problem you might ask? Tax arbitrage is outright illegal.

Grassley asked the non-partisan Congressional Budget Office to assess the extent to which tax arbitrage is occurring among universities. The CBO report indicates that:

the law as currently implemented allows many colleges and universities to use tax-exempt debt to finance investments in operating assets (buildings and equipment) while, at the same time, they hold investment assets that earn a higher return. (Investment assets are publicly traded and privately held securities, as well as land or buildings held for investment purposes.) To the extent that colleges and universities can earn untaxed returns on investments that are higher than the interest they pay on tax-exempt debt, they are benefiting from a form of “indirect” tax arbitrage.

the cost of allowing institutions of higher learning to borrow using such debt—measured in terms of the revenues that could have been collected if those institutions had borrowed using taxable debt—will be about $5.5 billion in 2010

Using data from information returns filed with the Internal Revenue Service by institutions of higher learning and by issuers of tax-exempt debt, CBO developed measures of tax arbitrage under a broader definition of the term that encompasses both direct and indirect tax arbitrage. Under one such definition, nearly all of the tax-exempt bonds that 251 colleges and universities issued in 2003 would be classified as earning profits from tax arbitrage. If some investment assets were set aside in a reserve, which would be excluded from the arbitrage measure under an alternative expanded definition, the amount of debt earning returns from arbitrage would be lower; even so, about 75 percent of bonds issued in 2003 would still be classified as earning arbitrage profits under that expanded definition.

"On the one hand, if colleges and universities use tax-exempt financing for projects that they would complete even without the subsidy, resources are just reallocated from taxpayers to the schools with no additional social benefit," the report says. "On the other hand, if the subsidy finances capital projects that would not otherwise have been undertaken and that create a social benefit in addition to the institution, it could improve the nation's welfare."

Additional coverage is available here, here and here.

Stop Subsidizing Institutions...Give the Money to Students

Here's my latest post on the CCAP blog:

Public colleges like to go around telling sympathetic listeners (especially legislators) that they are forced to jack up tuition charges because state subsidies are declining. Colleges and their sympathizers espouse the confusing rhetoric that the percentage of their revenues coming from state subsidies has declined, while failing to mention the reason that subsidies have declined as a percentage of their budget: because their rate of SPENDING has outpaced the rest of the economy over the past several decades. This is a much different story than saying, as Neal McCluskey and others have demonstrated: that public subsidies have generally been constant when adjusted for inflation and enrollment over the past 25 years.

The public has generally lived up to its bargain of subsidizing colleges in order to keep tuition affordable so that low and middle income people can get a postsecondary education. It is the colleges who have failed to live up to their end of the deal by engaging in a spending spree and empire expansion, mostly with taxpayer money, that has caused a surge in tuition. When organizations or people in the private world demonstrate an inability to manage their finances in a responsible manner, creditors cut them off. For those who sympathize with providing affordable access to college for the less-fortunate Americans, there is a solution that avoids turning off the spigot altogether: Stop subsidizing the institutions directly and instead subsidize the STUDENTS in the form of a voucher, grant or scholarship (whatever you want to call it) that follows the student to whatever college they choose to attend, regardless of ownership status.

That's right, empower students and their families to vote with their feet where the subsidies should be directed, rather than do so through the political process. This is akin to giving low income families food stamps to buy what they want rather than giving them bags of rice and beans. Schools eager to attract recipient students would then be much more likely to allocate their resources to areas important to students. The end result would likely be greater diversity in institutional models, with one extreme being a low cost online provider, the other the conglomerate country-club campus, and many variations in between.

We currently have institutional diversity to some extent, but the majority of public colleges are moving in the direction of the elite county club campus, making it less and less affordable for lower income students to afford to attend. So let's nudge them along to becoming fully privatized and elitist by cutting off their institutional subsidies and instead empower the students with the subsidies. My guess is that more institutions will move in the opposite direction, towards more value-based models focused on education. This would at least give students the choice in how they spend the taxpayer's money, and provide a glimmer of hope that it will be used more effectively. Doing so would also improve policymakers' ability to target funds to specific objectives, such as improving access to low income students or adult learners.