Senior Fellow Kevin A. Hassett

In the United States, almost everything is taxed. Sales taxes apply to the things we buy, property taxes apply to the things we own, and income taxes apply to checks we receive. Higher education is one of the few areas exempt from this ubiquitous taxation. The earnings of colleges and universities are, unlike yours and mine, untaxed.

Accordingly, our institutions of higher learning have accumulated enormous riches, as can be seen in the nearby chart. It shows how much money per student 15 institutions can earn on their endowments each year, depending on the rate of return. (These institutions have the largest per capita endowments.) Princeton’s annual yield exceeds $100,000 per student. Swarthmore College, my alma mater, has an annual cash flow equal to about $50,000 per student.

A fascinating new study by Richard Vedder, a professor at Ohio University and a fellow at the American Enterprise Institute, investigates the public-policy rationale for granting universities tax-free status. His review of the literature suggests that keeping universities tax-free does not equalize opportunities, as advertised.

Vedder cites a recent study by the National Center for Education Statistics that followed the post-high-school progress of mathematically talented students from the high-school class of 1992. The study found that, even among these students, socioeconomic status played a big role in college-graduation rates. By 2000, fully 74 percent of the more affluent students had achieved a bachelor’s degree. Only 29 percent of their poorer peers had.

Heavily endowed institutions favor the children of alumni, and have admissions criteria that are often much harder for disadvantaged kids to meet. Moreover, dropout rates are high, with only 60 percent of freshmen typically graduating. Some kids leave college with a degree and a big head start in life. Many have no degree, and painful debts to boot.

The institutions that serve low-income individuals best may well be the for-profit universities, such as the University of Phoenix.

So how should policy respond? Americans currently grant a tax break to universities that primarily serve wealthy kids, and none to many institutions that primarily serve the poor. There has been some talk of taxing universities more. But it would be better to treat the tax status of university endowments as a model for the rest of the economy. Under a consumption tax, the return on capital is not taxed--for anyone.

We should level the playing field by letting everyone else (especially the University of Phoenix and its for-profit brethren) operate under a consumption tax too. Universities have a right to their endowments, but their competitors should also have the right to accumulate capital tax free. 

Kevin A. Hassett is a senior fellow and director of economic policy studies at AEI.