Is Harvard Just a Tax-Free Hedge Fund?
According to the Wall Street Journal, Massachusetts legislators are studying a plan to levy a 2.5% annual tax on the portion of college endowments that exceed $1 billion. The high-wage union workforce with lifetime employment contracts and restrictive work rules tenured faculty is not amused.
Harvard’s official response is pretty funny:
Kevin Casey, a spokesman for Harvard, said the proposal would hurt Massachusetts and colleges because it would damage “stable bedrock institutions” that have helped shield the region from the worst of the economic slowdown.
But why isn’t this statement true of, say, Akamai, Biogen and Raytheon?
I’ve purposely picked companies with close ties to MIT and Harvard, because one could argue that universities create spin-offs that ultimately create corporate profits to be taxed. But large tech companies do the same; many successful companies are in the fourth or fifth generation of this process. Should Fairchild Semiconductor be free of paying corporate income tax because employees left to create Intel, or should this tax benefit revert to AT&T because a group of employees left Bell Labs to start Fairchild?
Which brings to mind another obvious question: why do endowed universities get tax breaks that other corporations don’t get in the first place?
Consider Harvard.
It claims to be in the business of serving humanity through the creation and dissemination of knowledge, but Biogen claims to “transform scientific discoveries into advances in human healthcare”. That sounds pretty good, too.
If you think of Harvard as a corporation, it had an income statement in FY 2007 with about $2.2 billion of revenues (tuition, sponsored research contracts, and so on) and about $3.2 billion of expenses, and therefore had to move about $1 billion from the endowment to make up the difference in order to run at basically break-even. In other words, it’s a big institution, but hey, it doesn’t make any money and has to survive on the kindness of donors, even if these donations are channeled through an endowment.
But this isn’t quite the whole picture. The overall Harvard corporation gets to make money through investment returns on its endowment (or, more precisely, the General Investment Account, which currently includes about $6 billion of investable assets in operational accounts in addition to the $34 billion endowment) that doesn’t get reported as revenue. Last year, Harvard made more than $7 billion of tax-free investment income.
So if you just think about how much cash went into the shoebox and how much came out of it, a more accurate accounting for Harvard for FY 2007 would, in rough numbers, be a lot more like the following:
Receipts = $2 billion of operating revenue + $7.3 billion of investment income + $0.6 billion of gifts to the endowment = ~$10 billion.
Operating costs = ~$3 billion.
Profit = $10 billion – $3 billion = ~$7 billion.
This explains why Harvard’s net assets increased about $7 billion in 2007, from about $35 billion to about $42 billion.
Viewed purely in terms of economics, Harvard is really a $40 billion tax-free hedge fund with a very large marketing and PR arm called Harvard University that has the job of raising the investment capital and protecting the fund’s preferential tax treatment.
The trick is that this hedge fund can’t remit earnings to investors, and has to keep them in the company’s account, renaming these retained earnings as an “endowment”. So how do the insiders extract value from this business? One way is by giving themselves cushy jobs that pay a ton of dough. Those who manage Harvard’s money are well-paid. The prior investment head, Jack Meyer, left after criticism of a compensation plan that paid some investment management professionals more than $35 million each in a single year. In spite of this, investment professionals often leave the Harvard Management Company because they can make yet more money as partners in private equity groups or hedge funds. Of course, the qualification of running Harvard’s pool of assets can be leveraged to get exactly such jobs – those who do this are called “Crimson Puppies” – while in the meantime enjoying a somewhat more relaxed work-life balance, and not having to do the hard work of actually raising the fund.
The worker bees in the marketing department (i.e., the faculty) are also quite well-paid. The average Harvard professor now has a salary of about $185,000 per year. Professors in the right disciplines, such as business, can reportedly double their salaries through outside consulting and other income sources. In 1980, the salary of a Harvard professor was about 5.5 times the average US per capita income; today, $185,000 is about 7 times the average national per capita income, and can often be leveraged into much higher actual annual compensation.
When tax-advantaged non-profits start to accumulate billions of dollars of cash through investment gains, and the insiders seem to be doing very well, it creates legitimate pressure for some legal changes. There is a broad range of alternatives: capital gains taxes on investment income, directly taxing the endowment, placing limitations on employee compensation, and forcing the distribution of a fixed percentage of the endowment are all obvious choices. Sanctimonious talk about “the mission of the university” is not likely to stop this; unfortunately, giving lots of money to Democratic politicians very well might.
( cross-posted at The Corner )
I believe Jim just brought the hammer down.
— Reihan · May 12, 06:58 PM · #
If only there were some way of taxing the compensation of Harvard’s faculty and portfolio managers — an “income tax,” if you will.
— alkali · May 12, 07:26 PM · #
“The average Harvard professor now has a salary of about $185,000 per year.” First it should be noted that that’s for Full Professor—not for lower ranks. Secondly, if [as I gather] it’s an average across all schools and disciplines, it’s almost certainly not true that the “average Harvard professor” makes this much. That’s like saying, in the famous example of Bill Gates walking into a bar, that the average barfly is a billionaire. A lot of those people, for instance, are medical-school types, who might well pull down over a million. I doubt that a historian or a German-literature specialist is doing that well.
— David in Nashville · May 12, 08:52 PM · #
So University of Houston has really taken off. They are a really good school now. Their entrepreneurship program was rated 2nd in the US and their business program is doing fantastic.
— Carl McHenry · May 12, 09:42 PM · #
So, so right. Any organization claiming that it’s “nonprofit” while it has a $30 billion endowment or whatever is a farce. And I don’t only indict Harvard in that, by the way.
Also, it really has negative consequences for the university as a system. I mean I’m told that at Harvard, Yale and Princeton, the top quartile of income-earning families make up 40% of their undergrad students. The bottom half of earning families contribute just 9% of the undergraduate populations. It’s just one facet of the ways in which elite universities aren’t really meritocratic systems, of course. But it’s inevitable when you feel you have to constantly grow such an enormous pile of money.
— Freddie · May 12, 10:29 PM · #
This is why I like the American Scene. Jim Manzi has posted a lot of “conservative” stuff I disagreed with. He makes what I consider typical conservative mistakes. He also posts reguarly on the Conservative Death Star. Yet here he is saying that there is something wrong with a private economic concern accumulating too much money, and that it makes sense to tax them (or that he can understand why people want to tax them). I am not a liberal (though I vote that way) but I am definitely not a conservative, so I have been looking for places that will give me ideas I don’t see because of my particular perspective, that, at the same time, are not staffed by political operatives or actual crazy people.
— cw · May 13, 12:32 AM · #
Oh, come on.
1) Harvard as a hedge fund: note that, at a normal hedge fund (two-and-twenty) with $30bn under management and $7bn in investment income, the amount of money that would be divided among the partners would be about $2bn, 10x larger than the total given to the managers of the Harvard endowment that year. That is to say, they are basically giving 90% of their potential income away.
2) Comparing Harvard professor salary to the average American presumes that there is nothing meritocratic about either academia as a whole or Harvard’s hiring practices. The average salary of a fully tenured professor at a major university is about $85k, and given that they are one of the most prestigious institutions, the fact that their top professors make about double that should be neither surprising nor alarming. Heck, compare it to the salaries of head football coaches at various state school, and tell me that smart people working to cure cancer don’t deserve the money.
3) The fundamental issue here is “What does it mean to be a nonprofit corporation?” This has nothing to do with mission statements or salaries: there are many for-profit companies who do great things for the world and whose owners/employees make very little. It has to do with the fact that the company is owned by its public-service mission rather than its shareholders. That is, profits beyond expenses are necessarily reinvested back in the activity rather than distributed as dividends, shared among parters, etc. Now, if you want to ask whether, at some point, the goals of a non-profit corporation are skewed away from the interests of society, that is something to debate. But until the government is equally willing to go after the Bill and Melinda Gates foundation, I will see this as nothing but desperate legislators looking for cash.
— Kartik · May 13, 12:37 AM · #
Jim, I’ve been a fan your articles for a while, but I too disagree with the taxation of Harvard’s endowment. While I am not affiliated with Harvard, I have worked at several similar institutions. The fact is some of these schools- maybe not Harvard- need this extra money. For instance, Penn’s new proton therapy center is expected to cost at least $140 million. That’s a large cost even for a school with a reputation like Penn.
I believe that companies like Biogen should pay a lower tax rate than many companies that do not have a direct benefit to society. Of course this complicates matters since Harvard’s endowment goes to both direct and indirect societal benefits. Perhaps schools like Harvard could pay at an intermediate rate?
Another point I think you are overlooking is that the money in Harvard’s endowment has already been taxed several times. For an alum to donate money, it has already been taxed- likely in the highest income bracket- and probably retaxed at the capital gains rate. I think double taxation is enough. We shouldn’t be advocating for triple taxation.
Comments on professors’ salaries are also far off base. As pointed out, it takes a long time to become a full professor. Many of these individuals (at least the ones who don’t have Asperger’s Syndrome) could make far more in the private sector.
— James Durgin · May 13, 01:23 AM · #
Kartik:
I get where you’re coming from on these comments. Here’s my take, keyed to your numbers:
1. True, but the carry tends to get grossly disproportionately distributed to the partners that generate the investment – that is, that have the investment track record, gravitas and sales ability to get CALPERS to put the money in the fund, especially the first fund in the series. None of this is done by those who invest the endowment. Those who pick and supervise investments are a (very highly paid) commodity. There is a total career lifecycle benefit for those at HMC (in that they develop the track record that lets them participate in raising a fund and getting carry once they leave Harvard) and a lifestyle benefit that makes up a lot of the remaining difference.
2. I think there is a lot that’s meritocratic about it, though (i) it’s meritocratic in terms of being (more-or-less) good at school, which people in school tend to over-generalize as that which has high market value, and (ii) that’s why I included the 1980 vs. today comparison — to make the point that the spread in comp is growing.
3. In fact, a typical non-profit foundation such as the Gates Foundation is required by law to distribute 5% of its assets each year to maintain its tax-exempt status (as a rule-of-thumb, subject to all the caveats in any tax law). This is precisely because the tax preference granted to non-profits is not meant to apply to money that is piled up in a massive investment account and not used for the purposes that are seen as socially valuable enough to justify not taxing earnings.
— Jim Manzi · May 13, 01:34 AM · #
1. I’m not sure if anyone would say that Jack Meyer came to HMC for the career lifecycle benefit, or that he wasn’t also a valuable salesman in terms of encouraging large donors to contribute to the endowment. But even if what you say is true, the result seems to be an even more meritocratic version of a hedge fund: the people that are most compensated are the ones whose intelligence generates above-average returns, rather than those who are simply riding off a wealth of connections developed in a previous i-bank life.
2. I think the transition from 5.5->7 is fairly small, given the fact that Harvard has become a much more prominent research institution in the last 25 years and that the overall American wealth gap has ballooned far more. Given the fact that institutions like Harvard have to compete with ever more lucrative job options, a modest increase in relative salary is more than expected.
3. Harvard is similarly (internally) mandated to distribute something like 5% of its assets each year: because of the nuances of academic budgeting, distributions are set a fiscal year and a half before they are made, and the incredibly high performance of the endowment during the last few year have made the distributions more like 3.5-4%. Moreover, most of the endowment exists to support specific, independently determined costs. For instance, a endowed chair (the professors that receive salaries like $185k) requires a donation of about $3.5m to make sure that the output of the fund will guarantee to pay the professor every year. If the managers outperform long-term expectations, should the professor get extra money just to make sure 5% is distributed? Or should Harvard be required to withdraw more money from some other fund? It’s not like they can use the money in the endowed chair fund to do more cancer research.
— Kartik · May 13, 02:12 AM · #
Kartik:
1. I certainly agree with you about Jack Meyer. I think that academically-oriented people often look down on salespeople as not really being inherently valuable, but that in almost any organization I can think of, the real money goes to the people who generate revenue. “Merit” does not equal “good at school”.
2. I agree that this is an example of the increasing inequality in the US. I think that this is a problem, and related to same underlying dynamics that are driving up the value of the endowments at elite universities. If you’re interested, I’ve written an article about this for National Review, decrying it as undermining social cohesion.
3. Like lots of people, I’ve run budgets, and I’m failry confident that, if properly motivated, I could figure out how to spend pretty close to X%.
— Jim Manzi · May 13, 04:44 AM · #
James:
I have a very simple solution: eliminate the corporate income tax.
— Jim Manzi · May 13, 04:46 AM · #
I don’t think Harvard faculty are underpaid, but it’s a bit silly to compare a wage-earner’s salary to “per capita income.” It’s very likely that the per-capita income in the average Harvard faculty member’s household is considerably less than “seven times the national average,” and for many it’s likely to be less than twice the national average. You may think this is still too much, but it doesn’t seem outrageous that people who are among the best in the world in highly specialized fields that require a lot of education and training, and who only get tenure (and the salaries the articles point to) after a very long apprenticeship (not before their thirties, at the earliest), in one of the most expensive regions of the country should be getting twice the national average of per capita income.
— Hartley Spooner · May 13, 04:49 AM · #
Brought the hammer down — and hit the nail on the head. I already suggested under a previous post to turn Harvard in a for-profit (not that something is right just because I proposed something similar).
As a matter of fact, capital taxes make economic sense, because they encourage more efficient capital. If you want to pay the capital taxes, you need to generate a return on that capital, and if you can’t, sell it to someone who will.
Many schools in France have a for-profit status, because non-profits are hard to manage. My old prep school is incorporated as a for-profit company, whose majority shareholder is the alumni association, which encourages greater alumni involvment in the school life (and donations), but also more change-aversion. I don’t necessarily believe this should be the case with Harvard (or with my school, for that matter), but this is just to say that there are many forms an educational institution can take, and they can survive taxation.
— PEG · May 13, 06:40 AM · #
I like how you fail to mention what the portfolio managers currently make, since that data is readily available to the public.
— liveinvt · May 13, 11:45 AM · #
As a grad (class of ’90) and constant recipient of fundraising appeals from fair Harvard, I’ve often thought that for a non-profit institution, they make a heck of a lot of “non-profit”.
— RedCharlie · May 13, 02:16 PM · #
I like how the article concludes with insinuations that personal donations to Obama’s campaign will persuade this issue to not materialize into federal law. Obama isn’t running for congress anymore, he won’t be able to pass federal law. Additionally, the source of this whole issue came up at the MA state legislature.
So what is the point of that shot being fired? Nothing directly related to the issue, therefore the author seems to be trying to discredit the educators at Harvard University for exercising their rights to support campaigns as individuals. Nice. I’m not some ivory tower cheerleader or anything, but it’s part and parcel with the rest of this rhetoric.
— liveinvt · May 13, 04:44 PM · #
liveinvt:
One of the most likely (other than the most likely, which is nothing) reforms would be to change federal law to require specific payouts from the endowment for tax-exempt educational institutions. The best possible solution, in my view, would be the elimination of the federal corporate income tax altogether.
— Jim Manzi · May 13, 07:34 PM · #
I also think the corporation tax should be abolished. In the meantime it makes sense to require university endowments to distribute 5% per annum like other foundations or be taxed. Actually, you are making me think about how non-profits should be treated if there were no corporation tax. The income will be taxed if it is handed out to faculty etc. as wages, possibly scholarships etc. should be taxed too – but then a university could just cut its fees to get around that one…
An alternative is to have a version of the system we have here in Australia where there is a corporation tax but tax payers receive tax credits for the tax paid by the corporation and then tax any non-profit that doesn’t distribute enough.
BTW – regarding your opening statement – US professors aren’t allowed to belong to unions. At least that’s what I was told when I was a professor at RPI (I earned $75k as Associate Prof of Economics).
— moom · May 13, 10:50 PM · #
If a full professor is making $185K, let’s remember how he got there (lets consider cancer researchers with PhDs not MDs)
As a graduate student for 6-7 years, our prof made in current dollars about $25K/yr. He did not pay tuition, but didn’t exactly live high. If he had student loans from college, they are still accruing.
As a postdoc for 5 years, he made in current dollars about $40K. That’s WITH a PhD from a Harvard-esque institution.
Then 6 years as an assistant prof and 6 years as an associate. Each promotion is up or out: you don’t make it, and you are tossed back into a job market that is oversaturated. You are likely to be living far from home, too, as you take what you get.
He crawls into Harvard tenure TWENTY THREE YEARS after he graduated from college. At age 45, if he’s lucky.
The average age for a first faculty position in the sciences is creeping up towards 40. That’s BEGINNING the slog to tenure.
So try being a postdoc 40 years old, with two kids, trying to explain to your dad why your income is about $45K a year, and you don’t have any retirement benefits, lousy med benefits and no dental. And explain to your wife that yes, you really DO have to work 80 hours a week in the lab to get that paper that might get you a job and a chance at 12 years of waiting for job security.
NO ONE does this for the money. If we wanted money, we’d have gone to med school.
— Realty check · May 14, 12:35 AM · #
James Durgin:
There’s one thing I don’t get about the idea of double and triple taxation. So say I want to donate to harvard. I get paid a salary which gets taxed. Then I buy a stock and make a bunch of money and then sell the stock. The money I made gets taxed. Then I give it to Harvard and then Mass. taxes it (in theory). Is that money triple taxed? Is that an example of what you are talking about? Because I don’t really get it. Money was given to me for a salary and taxed. The I made NEW money and that was taxed. Then I gave that money to someone else and that was taxed. But it wasn’t my money anymore. I think the principal is when money changes hands it gets taxed. But that’s not the same thing as double taxation. It seems like double taxation would be if you got some money and it was taxed and then that same money (not the gains for investment which is new money) was taxed again without it changing hands.
— cw · May 14, 04:05 AM · #
CW and James Durgin: Here’s the trick. You earn money which is taxed. Then you buy stock, say, $100 of Company XYZ stock. Years later when the stock is worth $1000, you give the stock directly to Harvard; so $900 worth of capital gains was never taxed. In addition, you get a tax deduction for the whole $1000, which possibly overcompensates for the taxed earnings used to buy the original stock. The whole double/triple… taxation argument is a wonderfully amusing canard, however.
— tedb · May 14, 04:50 PM · #
I knew I was right. That’s one more blog point for me.
ps. Doesn’t canard mean goose in French, or something like that?
— cw · May 14, 10:09 PM · #
Just seven more blog points and I win the right to pre-order a limited edition seasonal webkinz.
— cw · May 14, 10:12 PM · #