As I recounted recently in the Wall Street Journal, 20 years ago Milton Friedman wrote me to say, after doing a complete analysis, he believed we should be taxing our universities rather than subsidizing them. The economics involved are pretty straightforward: Activities that have good spillover effects (what economists call “positive externalities”) should be subsidized by governments, while those that impose costs on society should be taxed.
The federal government appropriately subsidized the production and manufacture of COVID-19 vaccines, since if person A received the vaccine, he or she provided some protection to unvaccinated persons B and C. By contrast, the manufacturer who pollutes the air or a stream is imposing costs on society—justifying taxation or special fees.
It is assumed that universities provide positive externalities. As a college-educated worker, Mike learns skills, work discipline, and honesty through his university training. He likely imparts some of those positive attributes to his colleague Michelle, who didn’t attend college. College-educated workers raise labor productivity through the “learning by doing” of coworkers. Therefore, we should subsidize university attendance to increase those positive externalities. Accordingly, we have state-subsidized universities, Pell Grants, and subsidized student loans. Likewise, private foundations and individuals support college attendance through scholarships.
But what if colleges and universities exhibit negative externalities? What if professors encourage or support student rioting, causing property damage or loss of life? What if their teachings destroy or weaken the glue that binds us together as Americans, perhaps through woke ideas inconsistent with the traditional American values most of us still hold? What if professors and/or students advocate murder (genocide) during hateful speeches targeting individuals based on their religion, skin color, or other attributes? What if universities have more negative than positive externalities? Then a strong case could be made to tax them. (Independent of the presence of externalities, some taxation is necessary to finance basic governmental functions such as national defense and other activities.)
With few exceptions, colleges and universities depend on third parties—governments or private donors—for the financing they need to survive. Even for-profit universities rely on federally subsidized student financial assistance. Reducing subsidies is a serious concern to university officials, but imposing major taxation is potentially lethal.
Two important considerations need to be recognized. First, not all universities are the same—some exhibit positive externalities while others demonstrate net negative ones. This poses problems for the broader comprehensive taxation of universities. Second, there are many different ways to tax universities, and multiple levels of government would be involved—federal, state, and local.
Not All Universities Are Equally Good Or Bad
Elite, highly selective, and rich schools like Harvard, Duke, Northwestern, and Stanford are radically different than two-year community colleges, most private liberal arts schools, or nonselective second-tier state universities. The most negative behavior in this collegiate annus horribilis has come from the elite private universities engaging in the most outrageous acts of antisemitism and violence. They have stridently proclaimed the supremacy of social justice as the collegiate mission—as opposed to the acquisition and dissemination of knowledge. Racial equality or other forms of identity politics, for example, trump discovering new vaccines or ingenious forms of artificial intelligence as a paramount university objective at many top schools.
By contrast, community colleges or lower-tiered state universities have been relatively peaceful. This is an argument for selective taxation of universities to reduce negative externalities. Additionally, one way of penalizing universities—reducing state government subsidies—is not generally available for private elite universities.
How Do You Tax Universities?
State and local governments derive much of their income from sales, excise, or property taxes. Governments could assert that university assets not purely serving academic purposes should be taxed. Property taxes are imposed on privately owned housing occupied by some college students, but not on university-owned housing. Meals eaten by students in restaurants or bars are usually subject to sales taxation, while university-provided meals are not. Perhaps it is time to remove those tax privileges, nudging schools into behaving as they should. Maybe tax stadiums (built for ball-throwing spectacles, not academic functions), but not classrooms and laboratories.
Taxing an institution’s income and wealth is an option at both the state and federal levels. Since 2017, there has been a small federal endowment tax imposed on wealthy schools (about 35). House Ways and Means Committee chair Jason Smith has called for quadrupling that tax, and Sen. J.D. Vance (R-Ohio) has advocated a far higher levy that would materially hurt the rich schools (and unquestionably lower future gifts). Another idea is to simply prohibit income tax deductions for university gifts. The federal government could also reduce overhead payments associated with research grants, although this might burden a legitimate core university function.
Send An Appropriately Sized Message
My instinct tells me an impactful financial cost imposed via reduced appropriations and enhanced taxation of university assets could be levied without dramatically impairing academic functions. Schools would complain bitterly, but they would make some much-needed spending reductions—such as reducing DEI apparatchiks and more efficiently using human and physical resources. Give a good nudge to the universities, remind them they are utterly dependent and that they cannot run ideologically driven woke academic villages at public expense.