Why do Universities Have Tax-Exempt Endowments?

The debate over the proposed tax on Harvard’s endowment continues, with my favorite contribution coming from one of Brad DeLong’s commenters:

Harvard is an investment bank with a mom-and-pop non-profit enterprise attached to it for tax purposes.

It’s a good point: what would happen if Goldman Sachs decided to buy back all its shares, start up a small university in Boston, and declare itself an endowment?

DeLong’s point is more substantive, and concentrates on universities as providers of educational services: by that light, Harvard has been much less successful than, say, the University of California. John Gapper concentrates more on universities as centers of "research expertise and prestige", which is all well and good but isn’t quite as obviously reason to exempt them from taxes.

And this argument of Gapper’s just doesn’t work for me at all:

The reality is that Harvard and the other universities contribute an enormous amount to Boston and Massachusetts and it is not as if they are squirreling their money away in Swiss bank accounts. Eventually, it will flow back to benefit the institution.

My problem with the Harvard endowment is that to all intents and purposes it is squirreling its money away in a (very high-yielding) Swiss bank account, and that only a tiny proportion of it ever flows back to benefit the institution. Gapper’s argument is far too trickle-down in feeling for my liking: you can oppose any tax on the basis that the money "will flow back" eventually.

Still, at least Gapper attempts some kind of a coherent argument. The Boston Globe, by contrast, simply denounces the plan as "economic suicide" and leaves it at that, spending the rest of the editorial doing no more than enumerating all the wonderful things that Boston’s universities do. Well yes – and I’m sure that the sponsors of the proposed bill envisage those universities doing just as many wonderful things in future. The question is whether the tax would drive the universities out of Massachussetts: my feeling is that it would have to be a lot bigger than 2.5% for that to happen. After all lots of people are happy paying a 2% tax on their wealth: they’re called hedge-fund investors, and they pay a 20% performance fee on top.

Overall, I’m struck by the weakness of the arguments against this proposed tax. That doesn’t mean that the tax is a good idea, of course, but it maybe does mean that the existence of tax-exempt university endowments is probably more of a historical curiosity than an educational necessity.

Update: See also Jim Manzi.