Dateline, April 4, 2007, Chicago
Senator Grassley is at it again. According to the Chronicle of Higher Education, the good senator has requested the Congressional Budget Office (CBO) to undertake a review of how colleges and universities utilize tax-exempt financing, as well as an analysis of the commercialization of college sports, with a focus on UBIT, corporate sponsorship payments, royalty income, booster programs, and a number of other issues. See Paul Fain, Senator Wants Reviews of Tax Breaks for College-Issued Bonds and Sports (April 4, 2007). As regular readers of this column know, we have been staunch critics of Senator Grassley’s activism. In our view, much of what Senator Grassley has focused on is best left to the IRS and state attorneys general. In this case, we have to...
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applaud Senator Grassley's efforts. That should not be taken to mean that we believe that colleges and universities are abusing their tax-exempt status. We leave that determination to the non-partisan and highly regarded CBO. But as the ranking member of the Senate Finance Committee, Senator Grassley has finally returned to the core function of the Senate Finance Committee, review of the tax laws and the value returned to society from tax subsidies.
One has to certainly wonder why colleges and universities with large endowments need to finance their facilities, particularly athletic facilities using tax-exempt bonds. The contributions that have produced those endowments are tax-deductible, and the income that adds to those endowments is exempt from taxation. So why should these schools be able to retain the income and then obtain a duplicative subsidy through tax-exempt bonds? As a general proposition, the arbitrage rebate rules are designed to prevent this sort of double dipping, but the rules apparently provide colleges and universities with enough leeway as to avoid the rebate rules.
We suspect that many college and universities are busy looking at last year’s CBO study pertaining to nonprofit hospitals and tax arbitrage. The CBO pointed out that the existing arbitrage rules may be too narrow. According to the CBO:
As administered, the existing rules in the tax code and the Department of the Treasury’s regulations limit tax arbitrage by restricting the yield on a bond issuer’s investments. Specifically, the yield can be no higher than the interest cost on the tax-exempt bonds if the bond proceeds are used to finance investment assets or if other assets are used to replace the bond proceeds (replacement proceeds), such as assets that are pledged as security for the bond issue.
The CBO study then goes onto examine the implications of broadening the definition of arbitrage. Based on its examination of existing data, the CBO concluded that a broader definition would reduce new issues of tax-exempt bonds by 28%. If we are reading the CBO study correctly, the broadening of the arbitrage rules would involve subjecting all investment assets in the arbitrage calculations. Under a less radical alternative, hospitals would be allowed to exclude some portion of investment assets from the arbitrage calculation on the theory that that portion is an appropriate be set aside for a rainy day. Under this approach, there would be a 9% reduction in issuances of tax-exempt bonds by hospitals. If this approach were applied to colleges and universities, the expanded arbitrage rules would include some portion of the endowment assets in the calculation. In short, the rules would focus on both indirect and direct arbitrage.
It is with some irony that the Chronicle of Higher Education reported on this story today. Just yesterday, for entirely different reasons, we were looking at the materials that the National Collegiate Athletic Association furnished to then Chairman of the House Committee on Ways & Means Bill Thomas when Thomas was reviewing the basis for the NCAA’s exempt status last year. Once again, we believe this is a perfectly appropriate inquiry. We also suspect that the NCAA, with its hundreds of millions of dollars in television contracts and licensing deals, knows it is in trouble. How do we know that? Well, the NCAA, in a report entitled Tax Law Basis for Tax Exemption of Intercollegiate Athletics, begins its justification for exempt status by returning to the Statute of Charitable Uses, an English statute that dates to 1601 and the reign of Queen Elizabeth the First. You know you are trouble when you are citing a foreign statute that predates televised sports by 350 years. This report provides a concise summary of the law that applies to tax-exempt organizations. It also focuses on education as an exempt function. The report also provides a detailed summary of the case and administrative law specifically addressing exemption issues and college athletics. But the report is completely out of touch with the state of college athletics today. It simply does not address the multi-billion revenue streams flowing to universities from these programs. No one can argue with a straight face that college sports is not big business. It is that fact that is causing the leaders of the congressional tax-writing committees to re-visit the question of tax exemption and appropriately so.
In a 25-page letter to Chairman Thomas, NCAA President Myles Brand attempts of justify the NCAA’s tax-exemption. Not surprisingly, he focuses on the benefits to the student athlete, the cross subsidization of unprofitable sports, and maintaining alumni interest and financial support. The latter two arguments are weak from a tax policy standpoint. The tax law long ago rejected the destination-of-income basis for tax-exemption, meaning that maintaining alumni interest and financial support is not a legitimate basis for tax-exemption. Depending on the level of generality, the cross-subsidization of unprofitable sports is subject to similar attack--is the unit of focus the college's athletic program as a whole or just the basketball or football program?). The strongest argument for exemption is the educational benefits to the student athlete (building character). President Brand shines the best light that he can on that basis, but everybody has heard the anecdotal evidence about low graduation rates and the exploited student athlete. It will be interesting to see whether the CBO addresses these arguments in its study.
Several answers to questions posed by Thomas will undoubtedly prove troubling to Senator Grassley, particularly if the CBO study confirms them. In particular, the NCAA was unable to tell Thomas how much of the television revenue was being channeled to academics. It also had to acknowledge that college athletic budgets were growing at a faster pace than academic budgets. We found the letter's efforts to justify tax-exemption rather hollow. It is clear that college athletics is a free-standing business, easily separated from the college and easily taxed. Alumni and the public are going to be no less enthusiastic if the federal government captures some of the largess for itself through unrelated business income taxes. That is the problem with running a commercial enterprise.
A word of warning. Museums and other cultural institutions that are moving in a more commercial direction should take note. Today it is the NCAA, but tomorrow it could be you. Commercial revenue is easy money, but it could have long-term costs, particularly as admission prices escalate and the activities of these exempt entities begin to compete with for-profit ventures. Moreover, museums with large endowments should be keeping an eye on any changes to arbitrage rules. Last month, Sally Beatty of the Wall Street Journal reported that museums have learned to love tax-exempt debt (March30, 2007, Museums Learn to Love Debt). If the Wall Street Journal has noticed, you can bet Senator Grassley has too.
As for Senator Grassley, we suspect he stands to learn a lesson from his latest crusade. College atheletics is not the Smithsonsian or American University, with a lax board and an apparently greedy chief executive. It is not the American Red Cross, which has admittedly had its share of problems. One of the NCAA's constituencies is alums. Another is sports fans. These folks live in every congressional district in the country. Senator Grassley can expect a vigorous and well-funded fight to maintain the status quo. Knocking off the NCAA is not going to be anywhere as easy as forcing Benjamin Ladner (American University) or Lawrence Small (Smithsonian) to resign. The NCAA's beer lifestyle is much more widespread than the champagne lifestyle that Senator Grassley has railed against in the past. Senator Grassley certainly shouldn't be counting on support from Senate Majority Leader Harry Reid, who constituents include the residents of Las Vegas, home to the famous casino sports books.
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