The Problems with Payouts: Assessing the Proposal for a Mandatory Distribution Requirement for University Endowments

Abstract

The endowments of wealthy colleges and universities became a subject of scrutiny in the popular press and in Congress before the economic crisis, when the funds seemed to grow annually by the billions without fail. But this growing wealth was accompanied by questions about whether universities were doing enough to support student financial aid, especially in light of rising tuition. Critics accused universities of 'hoarding' their wealth rather than using it to benefit current students. In response, lawmakers at the state and federal levels considered regulating or taxing university endowments. One of the proposals that gained wide traction would have required universities to spend at least five percent of their assets each year - a 'mandatory payout.'

This Note focuses on the mandatory payout proposal. I provide an introduction to university endowments and the endowment controversy, including the payout proposal. I survey the arguments for a payout offered by its proponents. I then trace the abatement of the controversy during the economic crisis and explain why we can expect scrutiny to return now, possibly at an even greater intensity.

I then argue that state and federal lawmakers should not adopt a five percent payout requirement. First, I explain why the strongest arguments offered by proponents of a mandatory payout are unpersuasive: a payout will not increase college affordability; the universities that would be subject to payout legislation are the wrong target because they already provide generous financial aid; and the comparison of university endowments to private foundations is misguided. Next, I explain why a payout will have harmful implications for colleges and universities: it will accelerate the academic arms race, constrain institutions’ ability to respond to economic fluctuations, risk harming American universities’ international preeminence, and lead to a decrease in spending in the long term. A payout may also become a ceiling, incentivising institutions not to spend above it. Finally, a payout will breach principles of university autonomy and academic freedom.

Keywords: university endowments

JEL Classification: I22, L31