The move by the state of Massachusetts to impose a 2.5 per cent tax on its biggest university endowments is causing an outcry. It is not surprising, given what is at stake for Harvard’s $36bn foundation.

The debate was reported in the Wall Street Journal on Friday after rumbling along in the state’s media and in higher education circles this month. State politicians are feeling the budgetary pinch and have put forward a bill to levy universities in the state that have endowments of more than $1bn.

At the moment, although universities such as Harvard and Yale can be regarded as some of the world’s biggest hedge funds, they have tax-exempt status. They do not even have to meet the requirement on other non-profit foundations in the US to distribute 5 per cent of their capital each year.

I think it is a bad idea, for reasons I will come to. And, surprise, surprise, there are plenty of Harvard economists who think so, including Greg Mankiw. But before I say why, it is worth acknowledging the arguments in favour.

First, state governments have to get their money from somewhere and Harvard, the Massachusetts Institute of Technology, Boston University and the rest are rich and powerful institutions. The tax-exempt status, for example, means that they do not have to pay taxes on property.

Second, the most successful university foundations have had an extraordinarily good run in recent years. In terms of financial wealth, they have pulled away not only from other US universities but the rest of the world. Which university does not look enviously at Harvard’s hoard?

Last, there is a case for redistribution. Brad DeLong describes how the University of California has grown hugely while Harvard has simply got richer. He does not say that, once upon a time, state universities such as Berkeley were comparable with private ones in terms of research expertise and prestige. No longer.

The reason for that is money. Going to Harvard or an Ivy League private university confers a clear advantage in the job market. I remember being told by one private equity executive that his organisation did not bother to visit anywhere other than Harvard Business School and the Wharton School for recruits.

Since its graduates tend to be richer, Harvard can then collect more money from them in donations. That makes it richer still, which gives it more research clout and more prestige, which increases its attractiveness. So a tax on its foundation might at least level the playing field a little bit.

Having said all that, I still think it is a bad idea. The reality is that Harvard and the other universities contribute an enormous amount to Boston and Massachusetts and it is not as if they are squirreling their money away in Swiss bank accounts. Eventually, it will flow back to benefit the institution.

As Greg Mankiw says, Harvard or any other university could also shift itself to a more tax-friendly location if it comes under pressure. The reality is that many places in the world would kill to host an elite university - just think of all the dismay in continental Europe about the lack of a comparable institution.

Above all, a leading global research institution is an extremely hard institution to create. The fact that Massachusetts has several should be a cause for pride and to treat them with kid gloves. They are indeed golden geese, which could be scared away.

Perhaps Felix Salmon is right that universities should come under similar rules as other non-profits - having to distribute 5 per cent of their capital annually to avoid taxation. But that is as far as it should go.

May 12, 2008 3:55am in Education | Comment