With the passage of the federal Tax Cuts and Jobs Act at the end of last year, many of the law’s provisions — including cuts to the corporate and individual income tax rates — have garnered significant attention due to the intense political fighting and maneuvering that occurred as the bill moved through Congress.
Among the new law’s lesser-known provisions is a new tax that will directly affect Dartmouth and its long-term financial outlook. Section 13701 of the bill creates a 1.4 percent excise tax on the realized gains of investments of private universities that have at least 500 students and that own investments totaling more than $500,000 per student.
Affecting about 30 other colleges and universities, such as Harvard University, this provision will most likely apply to Dartmouth and could cost the College about $5 million a year in new taxes, according to chief financial officer Mike Wagner.
Wagner said that since the regulations from the law have not been finalized, there is still uncertainty about how much of Dartmouth’s investment portfolio will be subject to the excise tax.
“There are a lot of parts of the regulations that still have to be worked out in terms of how that calculation of endowment to student is going to be done, and then what income is going to be taxed versus not taxed,” Wagner said.
The main source of uncertainty currently is whether the new provision will apply to all of an institution’s investments or just gains from its endowment, Wagner said. He noted that while Dartmouth’s endowment currently sits at around $5 billion, the College also controls about $1 billion in additional investments that are not considered part of the endowment.
Wagner said that the estimated $5 million in new taxes, which Dartmouth’s financial staff calculated based on previous years’ investments, should not have a major immediate impact on the College’s spending distribution of the endowment.
“When you deduct $5 million [from] the $5 billion of endowment, that doesn’t have a really big impact in year one,” Wagner explained. “So that’s why we talk about [the tax] having a long-term impact as opposed to a short-term one.”
Either way, Wagner added, the new tax should not affect the $100 million that Dartmouth spends each year on financial aid nor should it necessitate an immediate change in asset allocation or investment strategy. However, in the long run, the potential investment gains that could be accrued from the lost tax dollars could cost the College hundreds of millions of dollars from the endowment after 20 or 30 years.
“What [the new tax] will do is make our assumptions about growth in resources grow slower [and] flatter,” Wagner said.
With proponents of the new law arguing that its tax cut provisions will spur increased economic growth and therefore better market conditions, Wagner said that if Dartmouth’s endowment returns remain high in coming years, the effects of the excise tax will be less severe. For the 2017 fiscal year, the College reported an all-time high 14.6 percent return from its endowment investments.
“If returns continue to go really well and above our assumptions, the 1.4 percent tax will not be particularly meaningful,” Wagner said, but added that if returns flatten out or decrease, paying an additional tax would make things worse.
Other provisions from the new law could have a more indirect effect on the College. Notably, the law raises the standard tax deduction for married couples and doubles exemptions on the estate tax, which could potentially disincentivize individuals from donating money to nonprofits.
Economics professor Bruce Sacerdote wrote in an email statement that while he is concerned about the potential of decreased charitable giving, the effect on Dartmouth may be minimal.
“Fortunately the biggest donors will still have a strong incentive to give since these donors will still itemize,” Sacerdote wrote. “However, Dartmouth is about broad participation not just dollars. Time will tell how much this tax change impacts giving.”
Likewise, Wagner said that it is too early to tell whether the increased deductions and estate tax exemption will affect the propensity of Dartmouth’s donor base to give to the College, but he added that people who give at a high level are likely to do so because of their passion for the institution rather than for tax or estate planning.
Another aspect of the new law that Wagner marked as potentially concerning is the fact that the excise tax will not affect all of Dartmouth’s peer institutions equally. Since the tax only applies to universities with investments totaling more than $500,000 per student, peer institutions like Cornell University and Brown University with larger student populations but similar-sized endowments will be exempt, according to the Concord Monitor.
Wagner said that as a result, schools like Dartmouth that must comply with the new tax may be disadvantaged as they compete with peer institutions for students and faculty.
While proponents of the law could argue that the new excise tax was created to offset revenue losses from the provisions that cut taxes in other areas, Sacerdote wrote that the potential revenue gains will be minimal.
“The tax only raises $1.8 billion over 10 years,” Sacerdote wrote. “It’s peanuts. It would have been far better to have had a smaller reduction in taxes for pass-through corporations that make $1 million or more. This tax is not an effective way to raise revenue.”
College executive vice president Rick Mills agreed that the new excise tax seems unnecessary if additional economic growth is assumed from the other tax cuts.
“In the context of the full United States federal government, this tax isn’t generating a ton of revenue to help pay for this new tax bill,” Mills said. “It feels a little bit more like a popular political statement about wealthy institutions.”
For now, however, Mills said that the law should not fundamentally affect Dartmouth’s financial outlook, at least in the short run.
“It doesn’t immediately change what Dartmouth does or is — we can cope with it,” Mills said. “But it has changed what the environment for Dartmouth feels like in the longer term.”
