Colleges And Taxes: A Modest Proposal

Our federal tax system fails on four important criteria: it is overly complex, it retards economic growth because it leads to the inefficient uses of resources, it is often unfair, and it is not even fully transparent. Our system of higher education also fails on four important criteria: it is terribly inefficient and too costly, it is increasingly producing dubious learning outcomes, it turns out too many students who fail to graduate and/or who get unskilled jobs not requiring m

Tax Relief

uch formal education, and it is increasingly not serving its vital role of providing intellectual oases where there are unfettered discussions of widely diverse perspectives without fear of harm or intimidation.

Any revision of the tax code is heavily constrained by a fiscal reality: the federal government has a substantial fiscal imbalance, irresponsibly spending far more than it takes in even eight years into an economic recovery. Any tax reform must face the difficult task of both enhancing economic growth in a fair way while, minimally, not worsening the problem of a high ratio of federal debt to national income and wealth. While it will not be a full solution, ending dubious tax policies regarding higher education will help pay for such needed changes as reduced corporate income taxes or the elimination of the alternative minimum tax, while at the same time encouraging reducing university waste and high costs.

Milton Friedman once suggested to me that it is an interesting proposition whether we should be subsidizing universities or taxing them. Aside from sizable cash subsidies to universities and student financial assistance that has helped enable high tuition fees, the federal government provides tax benefits worth literally tens of billions of dollars annually. Clearly, the biggest item, approaching $20 billion annually, is tuition tax credits, which allow individuals to lower their tax bills by paying tuition, which has unquestionably contributed to the doubling of the real cost of going to college in recent decades as colleges have raised their fees to capture these savings. Removing these tax credits would at least modestly reduce the demand for higher education and reinforce recent market-determined moves by colleges to moderate their fees.

Another example of a win-win tax reform relates to the interest rates colleges pay for new construction. Generally, colleges can issue debt exempt from federal income taxes. That lowers their borrowing costs and has contributed to an Edifice Complex and mounting college debt obligations, as schools have borrowed copious amounts of money to build ever fancier facilities, such as academic buildings with fancy atriums, housing units with marble countertop kitchen facilities, climbing walls and “lazy rivers,” and, especially maddening on equity as well as efficiency grounds, elaborate stadium sky boxes so wealthy alums can, for a high price, drink beer or fine wine while watching recent adolescents engage in energetic ball throwing contests. My university openly has bragged about its issuing century bonds–IOUs with a 100-year maturity, leading it to construct buildings that will long torn down before they are paid for.

Yet this fiscal pathology is relatively small compared with the favorable tax treatments on gifts and investments, a benefit that accrues disproportionately to very rich schools like Harvard and Stanford. Schools like Yale and Princeton have roughly $2 million in endowment money for every student attending the schools, providing perhaps $100,000 income per student. Yet these schools still charge many of those attending high tuition fees, so a large proportion of students come from relatively affluent families. Why do we let people reduce their taxes by gifts to these obscenely wealthy schools that charge students high fees? Why do I have to pay 23 percent on any capital gain I make to the Feds and additional amounts to the state of Ohio, but my alma mater, Northwestern, pays nothing on its efforts to expand its roughly $10 billion endowment? Why are we subsidizing the strengthening of wealthy academic gated communities, institutions benefiting far more from tax policies than, say, typical state universities? This is promoting a growing inequality within higher education—the “haves” are prospering more than the “have nots.”

The discussion above is not comprehensive. I have not discussed for example, the tax advantages students obtain on interest payments on the $1.4 trillion or so in student debt, a policy that encourages student borrowing and contributes to tuition inflation. Nor have I explored the secondary effects, for example, the impact that some of these benefits have on the definition of taxable income at the state level.

Moreover, many restrictions in these tax privileges should garner both Republican and Democratic support. Republicans are especially annoyed at universities, Pew Research tells us. Democrats who profess to favor helping the disadvantaged should favor taxing the rich university enclaves (although some attended these institutions). Ending tax subsidization of stadium sky boxes should have popular appeal. Attacking higher education tax privileges can only finance a small portion of some needed tax reductions, but every little bit helps.

Richard Vedder directs the Center for College Affordability and Productivity, teaches as Ohio University, and is an Adjunct scholar at the American Enterprise Institute.