University endowment returns are underspent - Higher Education - Statistical Data Included

Challenge, July-August, 2002 by Donald Frey

History is instructive. People in the 1930s were poorer than were people in the 1920s, but most financial portfolios were worse off after 1929, too. The depression also reminds us that even the largest deviations from the trend of rising incomes have been temporary In short, any equity case for underspending endowment rests on two highly improbable propositions: first, that the long-run trend of rising incomes will be permanently reversed, and, second, that financial wealth can somehow survive such a reversal.

Donor In tent: Do Universities Honor It?

Another norm for judging the rate of university spending is the intent of the donors to endowment. Although there are different categories of donors, members of each category seem to intend the spending of all endowment returns.

Charitable tax deductions in effect make government a large donor to university endowments. A private donor of highly appreciated common stock can avoid a 20 percent federal capitalgains tax and also enjoy a federal charitable deduction on income tax worth as much as 35 percent of the donation (even after the 2001 tax law is fully implemented). Add state tax deductions, and governments may provide tax benefits worth as much as 55 to 60 percent of gifts to endowments. (Some donors may face restrictions on the size of the deduction for a given year.) Top rates for inheritance taxes (prior to the 2001 tax law) yielded benefits of the same general magnitude for bequests to endowments.

Governmental tax deductions are surely meant to increase the activity of recipient institutions (instruction and research in the case of universities). Can one believe that tax incentives exist to help nonprofit organizations accumulate wealth as an end in itself? Such an interpretation is so arbitrary and so inconsistent with other social policy that it is easily ruled out. For example, federal law imposes minimum spending requirements on philanthropic foundations, which ensures that they actually engage in philanthropy, not merely wealth accumulation. A nominally progressive tax structure to some degree retards the concentration over time of wealth among individuals. Is vast wealth concentration over time approved as a function of nonprofit institutions?

Private donors of large gifts to endowment infrequently have made explicit their intentions regarding spending rates. During its historic campaign to encourage universities to invest in equities, the Ford Foundation surveyed donor intent in giving to endowments (to demonstrate that there were no restrictions on investing for total return). Twenty-two percent of "donative instruments" in the Ford sample imposed no legal impediment to spending even the principal of the gift--permission extending far beyond spending merely investment returns. No donors were reported to have required regularly spending less than all earnings. A few "specified that a definite sum of money ... be devoted to a specified purpose each year, regardless of whether the 'earnings' of the fund were more or less than that amount." (8) This statement suggests that donors were primarily concerned with program support regardless of the level of spending required. We may conservatively conclude that many donors of large gifts have left no evid ence of a desire that spending should be less than the total return on invested funds.