Government

Final Tax Bill Would Spare Some Higher-Ed Worries, but Could Lead to State Budget Cuts

December 15, 2017

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After a compromise was reached on Friday, Republican legislation to overhaul the federal tax code is headed for final votes in Congress without a tax on graduate-student tuition waivers but with a tax on big college endowment earnings.
The Republican-backed tax overhaul is headed for final floor votes in Congress without some of the measures that would directly target higher education. Notably, a proposed tax on tuition waivers for graduate students and other college employees is no longer in the compromise legislation. But a high-profile tax on the investment earnings of some of the largest college endowments stayed in the bill.

A conference committee, convened by Republican leaders in Congress, agreed on Friday to the final terms of the bill, which now faces votes in the U.S. House of Representatives and the U.S. Senate. The House is expected to vote on December 21. Odds for the bill’s passage increased on Friday when two potential holdouts, Sen. Marco Rubio, Republican of Florida, and Sen. Bob Corker, Republican of Tennessee, said they would support it. If majorities in both chambers approve the bill, President Trump is expected to sign it.

But even without some controversial measures, the overall package is still expected to have a significant effect on higher-education budgets. Within the bill are provisions that could curtail both state appropriations and college fund raising.

For example, the bill would double the standard deduction for tax filers, cutting the number of people who would itemize their charitable contributions. Many critics fear such changes would act as disincentives for donations to colleges. In addition, laws in many states require their tax rates to change with federal rates, a pattern that could lead to steep state-budget shortfalls as tax revenues decline.

Thomas L. Harnisch, director of state relations and policy analysis at the American Association of State Colleges and Universities, told a recent gathering of state higher-education lobbyists that the tax bill would leave public higher education vulnerable to deep cuts at a time when many state budgets have still not fully recovered from the Great Recession.

Lucy Dadayan, a senior researcher at the Rockefeller Institute of Government, part of the State University of New York, said the bill would reshuffle the “tax burden among various income groups without any coherent strategy,” but could have the greatest impact on high-tax states such as California, New York, and New Jersey.

“In general,” she said by email, “the tax-reform bill is complex and rushed, and would lead to many unexpected ramifications.”

Hits to Higher Ed

Over all, the legislation would lower the corporate tax rate from 35 percent to 21 percent, decrease the number of tax brackets for individual filers, and double the standard deduction for individual filers. Other notable measures include limiting deductions for mortgage interest paid and for state and local taxes paid.

The cost of those changes would add more than a trillion dollars to the federal deficit over the next decade, with some of that money offset by tax increases, including for some colleges.

A proposed tax on the endowment earnings of the wealthiest colleges remained in the bill. The legislation would place a 1.4-percent tax on the investment earnings of endowments at colleges with more than 500 students and $500,000 in endowment per student. The provision is expected to affect fewer than 30 colleges nationwide, though the number could certainly grow. A small change in this section states that the tax applies only to “institutions more than 50 percent of the tuition paying students of which are located in the United States.”

During debate over the Senate’s version of the bill, Sen. Pat Toomey, Republican of Pennsylvania, proposed an exemption from the tax for colleges that decline to accept federal funds, a plan seen as helping a single institution, Michigan’s Hillsdale College, the beneficiary of many conservative donors. The “Hillsdale Carve-Out,” as it came to be known, was rejected in the Senate’s final bill.

Larry Arnn, the college’s president, wrote that he believed the proposal was “fair” because institutions like his do not accept taxpayers dollars. But, he added, “as a matter of principle the government should reduce its subsidies to universities rather than taxing endowments.” Principia College, a small, private institution in Illinois that does not receive Title IV funds, would be at risk of being subject to the tax if it were to grow by roughly 20 students.

In addition to those measures, the bill would impose a 21-percent tax on annual compensation in excess of $1 million paid to any of a nonprofit organization’s five highest-paid employees. That’s a one-percentage-point increase from the legislation’s original measures. The provision would apply to colleges but appears to exempt medical professionals, such as medical faculty members who work at academic hospitals, according to higher-education experts who have examined the bill.

The final legislation would eliminate the 80-percent tax deduction that sports fans get to take for  “seat-license fees” paid to buy tickets to sporting events — a major revenue stream to big-time college-sports programs. Another provision would prohibit colleges from using a loss in one unrelated business to offset a gain in a different such business, potentially increasing their overall tax burden. Unrelated businesses are those not directly connected to their academic mission, such as recreation or fitness centers, sports camps, facility rentals, and golf courses.

Some of the most controversial measures affecting higher education, however, were dropped from the final bill. The compromise bill would avoid proposed changes in the Lifetime Learning Credit, valued at up to $2,000, and the $5,250 corporate deduction for employee education-assistance plans.

A provision to tax tuition waivers as income was scuttled after widespread protests by graduate students. The bill also would not remove the $2,500 deduction for interest paid on student loans.

And special bonds, called Private Activity Bonds, would still be available to nonprofit organizations such as private colleges and alumni foundations. An earlier version of the tax bill would have eliminated those bonds, which are often used for building projects.

A proposed tax on the royalties from licensing a college’s logo — for athletic clothing, for example — was also eliminated from the compromise bill.

Long-Term Effects

The most profound impacts on higher education will be detectable only in the long term and will be harder to calculate.

The provision limiting the deduction for state and local taxes paid would put pressure on states to constrain their own spending in areas such as higher education, says a report by Moody’s Investors Service, which counts the tax bill as a possible negative for the higher-education sector.

The provision doubling the standard deduction — the amount of income that tax filers are allowed to automatically shield from taxes — could hamper fund raising by colleges. The change, if enacted, would be expected to decrease the percentage of taxpayers who itemize their tax deductions, such as donations to alumni funds, from about 30 percent of filers to just 5 percent. Nonprofit leaders have estimated the provision would lead to a $13-billion drop in charitable giving nationwide.

Doubling the standard deduction could also put a huge dent in some state budgets, leading to cuts in appropriations for public colleges and state student-aid programs.

Some states have laws requiring their tax codes to conform with federal changes as they occur, according to the Tax Policy Center. Enactment of the final tax legislation could mean tax cuts for many people in those states, but also big drops in state tax revenue. Officials in Missouri, for example, have estimated the state will lose as much as $1 billion in tax revenue with the proposed changes in federal taxes, according to The Columbia Tribune.

States that rely on taxes on oil and gas drilling could also lose some of that money, according to Stateline.org. That could happen if the new legislation, if enacted, triggers the automatic suspension of those taxes under a 2010 budget deal that also requires cuts in federal spending, called “sequestration.”

Republicans in Congress are also now raising the possibility of more reductions in federal programs to pay for the tax cuts they are seeking. That could lead to more budget instability at the state level, said Kim Rueben, a researcher at the Tax Policy Center, because a third of state budgets come from federal dollars for programs such as Medicaid. “Future federal cuts are state cuts,” Ms. Rueben told the recent gathering of state higher-education lobbyists.

Ms. Dadayan, of the Rockefeller Institute, said the bill would “put fiscal pressure on some middle-class taxpayers as well as on some state and local governments.”

“In short,” she said, “there is a huge fiscal and economic uncertainty in front of state and local governments.”

Eric Kelderman writes about money and accountability in higher education, including such areas as state policy, accreditation, and legal affairs. You can find him on Twitter @etkeld, or email him at eric.kelderman@chronicle.com. Adam Harris is a breaking-news reporter. Follow him on Twitter @AdamHSays or email him at adam.harris@chronicle.com.

Correction (12/16/2017, 4:44 p.m.): This article originally misstated the name of a type of bond that would be preserved under the tax legislation. It is a Private Activity Bond, not a Performance Activity Bond. The article has been updated to reflect this correction.