Senator Questions Another Break for Colleges: Tax-Exempt Bonds

May 02, 2010

A U.S. senator with influence over federal tax policy may now be setting his sights on a longstanding cornerstone of colleges' financial practice: paying for new and renovated buildings by borrowing money with tax-exempt bonds.

The attention comes as a result of a just-released report from the Congressional Budget Office. The report, "Tax Arbitrage by Colleges and Universities," questions the merits of allowing nonprofit institutions to rely on taxpayer-subsidized debt while they also benefit from investing their assets to earn them more than what they pay out in interest on the debt.

The report says such a practice allows many universities to benefit from what it describes as "indirect tax arbitrage" because "holding those assets while borrowing on a tax-exempt basis is, in effect, equivalent to using tax-exempt proceeds to invest in those higher-yielding securities."

College advocates say the broad definition of tax arbitrage the report uses reflects an economic argument on the merits of tax-exempt financing but doesn't take into account the social good that colleges provide or the current financial pressures they face.

Sen. Charles E. Grassley, who requested the budget-office analysis in 2007 as part of a broad look at tax-exempt organizations, said in a statement on Friday that the report raises questions "for parents, students, and taxpayers about universities issuing bonds and going into debt when they have money in the bank."

The study estimates that allowing colleges and universities to borrow using tax-exempt debt will cost the federal government about $5.5-billion in forgone revenue in 2010.

In his statement, Senator Grassley, a Republican from Iowa, highlighted several concerns: "Issuing bonds costs money on interest and management fees. Does the expense of debt service take money away from student aid or academic service? Do bond issuances occur even as universities raise tuition and build investment assets?"

But it is unclear whether the senator, who is the senior minority member of the Senate Finance Committee, intends to propose any changes in law in response to the report. In the statement released on Friday evening, he says, "These are further questions to explore."

Charles A. Samuels, a lawyer for the National Association of Health and Educational Facilities Finance Authorities, a group of organizations that help private colleges issue bonds, said current law already restricts colleges and other organizations from directly profiting from their tax-exempt bond issues, or tax arbitrage. (To avoid tax arbitrage, a college that raises money from tax-exempt bonds can reinvest it only temporarily, and even then only in investments earning about the same as the cost of the debt.)

"Now would be a very bad time to make it more difficult for nonprofit organizations in this country to borrow money," Mr. Samuels said in an interview on Sunday.

He said the Congressional Budget Office report is "an 'academic' study in the worst sense of the word" and added that he hoped it would not result in some new limits on tax-exempt financing.

"It isn't going to really help the cost of higher education to restrict financing" that saves colleges money, he said.