FASB SHOULD WAKE UP AND SMELL THE COFFEE: MASSACHUSETTS TAX ON ENDOWMENTS
DATELINE: May 12, 2008, Chicago
As regular readers know, we are dissatisfied with proposed FSP 117-a, a rather obscure proposal being considered by the Financial Accounting Standards Board (FASB). It would extend current accounting principles to the financial statements of charities operating in states that have adopted the Uniform Prudent Management of Institutional Funds Act (UPMIFA). UPMIFA is spreading like wildfire, with at least 20 states enacting versions of it.
To make a long story short, FSP 117-a will continue the accounting profession's practice of overstating the amount of a charity's assets that are freely spenadable. For institutions with large endowments, this means that to donors and legislators, much of endowment looks like it is available for current expenditure despite legal restrictions which prohibit the institution's board from spending the funds. As our Jack Siegel pointed out in his recent article, FASB Puts Infinity Up on Trial: Accounting for Endowments, 60 EOTR 23 (April 2008), the inaccurate reporting mandated by FASB will pose serious problems for colleges and universities. For example, rising tuition and related costs...
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have caused many to demand that colleges spend a larger share of their endowments on scholarships and other programs to reduce the burden on students and their families.
Which brings us to the State of Massachusetts legislature. It now has taken note of the large endowments held by some of its educational institutions. Last Thursday, Peter Schworm and Matt Viser of the Boston Globe reported that state officials have been asked by legislators to study a proposal that would impose a 2.5% tax on colleges having endowments in excess of $1 billion. Lawmakers Target $1B Endowments: Exempt Status of Schoold Debated, May 8, 2008. The colleges and universities that would be taxed include Amherst College, Boston College, Boston University, Harvard University, Massachusetts Institute of Technology, Smith College, Tufts University, Wellesley College, and Williams College.
Representative Paul Kujawski, a backer of this proposal, certainly has noticed Harvard University's $34 billion endowment. He told the Globe, "It's mind boggling that one entity not paying taxes has $34 billion."
Even more mind boggling is the fact that a state legislator would propose confiscating the wealth of a private entity. Particularly notable about this proposal is the fact that it is not aimed as forcing increasing the aid available for current students. Senator Therese Murray, the president of the Massachusetts Senate told the Globe, "Some of these institutions give very little back to their communities. With such large endowments, they should be doing more." In other words, this is about raising revenue to run the State of Massachusetts. A specialist on college finances at a community college claims that the Big Boys aren't doing their civic duty.
No wonder the legislators are so interested in this new pot of money. The estimate is that the tax would raise $1.4 billion a year. The state's budget is currently set at $28.2 billion, meaning that the tax would produce roughly 5% more in spendable revenue.
In trying to explain why accounting principles our central to the debate over whether to force colleges to spend more of their endowments, Siegel, in footnote 70 to his article, wrote:
The harsh reality that will face the winner [of the 2008 Presidential campaign], whether Democratic or Republican, will be exploding entitlements, a deteriorating national infrastructure, the likely need for high levels of defense and antiterrorism spending, and a polarizing tax system. Against that backdrop, federal lawmakers and the president, to the extent they agree that increased discretionary spending is warranted, will have to figure out how to finance new subsidies. The easiest solution is to pass the cost on to someone else. Congress has discovered that unfunded mandates imposed on the state governments are one way to achieve that. Another is to force nonprofits with wealth to spend more of it, or face confiscatory taxes like the ones currently applicable to private foundations. I believe that large nonprofit endowments are just too tempting for politicians, who like slogans and give-a-ways to satiate ever-demanding voters that want more government services, but refuse to pay for them. This all seems obvious today, but the ever-prescient Professor Evelyn Brody anticipated this phenomenon more than a decade ago, writing:
A serious imbalance of resources in the nonprofit sector inevitably attracts attention. Not that we will see a reprise of Henry VIII's dissolution of the monasteries, but a revenue-hungry Congress cannot ignore the wealth held in the tax-exempt sector.
Evelyn Brody, ''Charitable Endowments and the Democratization of Dynasty,'' 39 Ariz. L. Rev. 873 (1997). Brody recently told me she believes the interest of politicians in college endowment spending is analogous to their interest in the amount of charity care provided by nonprofit hospitals. Both increasingly are viewed as the price of tax-exemption.
Jack was focused on federal proposals to force colleges to spend more of their endowments currently. The Massachusetts legislators have proved that the insatiable appetite for spending is not just limited to the United States Congress.
This grab for money makes accurate accounting even more of an imperative. That is why many eyes should be on the FASB. Up until now, the FASB has refused to adopt accounting principles that accurately reflect the limitations placed by donors on colleges and universities to spend gifts that become part of endowments. This is not a question of using accounting games to hide money or inaccurately report the size of endowments. The fact, as noted above and in detail by Jack in his article, is that accounting principles ignore a significant portion of donor and state law restrictions on colleges and universities to spend endowment. The FASB can correct this longstanding problem by deciding to rewrite the rules rather than extend them through the adoption of FSP 117-a in its current form.
The staff of the FASB unfortunately thinks this is all an intellectual game, taking pleasure at debating with lawyers who try to explain to the staff that the existing accounting rules are wrong because they produce financial statements that don't reflect legal facts. Those lawyers will move on if the FASB persists in clinging to the bad decisions that it made in the past. What is becoming apparent is that colleges and universities will pay the price of that stubbornness.
In the late Sixties, Wisconsin's then governor decided to increase taxes on Wisconsin's industrial base, which at the time included the machine tool industry. He is purported to have said, "What are they going to do, leave the state? They can't, they have too much invested in factories that sit on 10-foot slabs of concrete." Take a look at Wisconsin today. Most of the large machine took manufacturers have left the state.
The Massachusetts legislator may hold the same belief when it comes to its colleges and universities. Is Harvard really going to leave Cambridge? Those members of the legislature should be very wary of the law of unintended consequences. The world still envies the top U.S. colleges and universities. More and more of these universities are opening satellite campuses around the world. No doubt that wealthy foreign alums will want to further endow these schools. We suspect that those endowments will move offshore if the State of Massachusetts begins to tax endowments. We also suspect that United States alums may curtail their giving to these schools. And who knows what impact distance learning will have on the need to be located in Cambridge.
But before we need to think far into the future, the FASB could cutoff much of the debate, deciding to rewrite the accounting rules that apply to endowments so that the resulting financial statements reflect economic and legal reality.
The big question for Harvard and the others: Will Senator Grassley permit colleges and universities to count the Massachusetts tax toward the mandatory endowment payment that Senator Grassley would like to impose on college endowments?
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