Questioning Universities’ Tax-Exempt Status Over Their Middle East Views Is Dangerous

House Ways & Means Committee Chair Jason Smith (R-MO) has questioned the tax-exempt status of universities that, in his opinion, are anti-Israel. Whatever your views on the Middle East, Smith is swimming in very dangerous waters.

There are serious questions about the tax treatment of colleges and universities. But do we want to see their tax-exemption called into question, even implicitly, by politicians who disagree with their views on public issues? Would Smith be OK if a future Democratic-controlled Congress lifts the tax-exemption of conservative colleges for ideological reasons?

To be sure, Smith stopped just short of threatening to repeal the tax-exemption of universities that do not share his views. But his message was not hard to miss. In a prepared statement after Hamas terrorists killed more than 1,000 people in Israel on October 7, he said, “Some organizations that have celebrated the unspeakable acts of terror…currently enjoy tax-exempt status in the United States, and their statements call into question the academic or charitable missions they claim to pursue. University administrators…fail to condemn actual violence that threatens our way of life all while their institutions enjoy lucrative federal tax-exempt status.”

Universities As Public Charities

Nonprofit colleges and universities generally enjoy Section 501(c)(3) tax-exempt status as public charities.

It grants donors the ability to deduct gifts to these institutions. It allows nearly all colleges to avoid tax on earnings from their endowments. The schools also are free from state and local taxes — including, importantly, real estate taxes on their often-substantial property holdings. And they can save borrowing costs by issuing tax-exempt bonds.

And while in theory, only their income from activity substantially related to education is tax-exempt, in practice, the billions of dollars universities make from their near-professional sports teams also are tax-free.

The tax exemption is a very big deal. According to one study co-authored by Tax Policy Center’s Adam Looney, the federal tax exemption alone is worth $1.7 billion to the schools. The tax deduction for their donors reduces federal revenue by another $8 billion annually.

Congress made academic institutions tax-exempt because it believed education fosters a productive, civic society. That ought to include open debate and expression of unpopular, and even repugnant, thought: an idea that recently has come under fire from both the Left and the Right.

Not The First Tax

Smith’s comments are not the first time in recent years that congressional Republicans have attacked the tax-exemption for universities. The 2017 Tax Cuts and Jobs Act imposed a new 1.4% tax on the net investment income of schools with very large endowments. The IRS reported the levy was paid by only 33 institutions. Other analyses, including this one by the Urban Institute’s Sandy Baum identified the schools. Most were considered excessively progressive by the GOP lawmakers who proposed the tax.

Still, there are plenty of good reasons for Congress to broadly rethink the tax-exemption. Many schools are huge landowners.

NYU and Columbia University, for example, are among the biggest in New York City. But they pay no real estate taxes even though their property often is leased for profit and has nothing directly to do with the school’s tax-exempt purpose.

Sure, the real estate revenues help build endowments that could help pay tuition for low-income students. And the property may contribute to local economic development. But how often do students see the benefits of these investments?

Big-Time Sports

Then there is big-time sports. The NCAA reported that in 2019, athletics generated $15.8 billion for colleges and universities, mostly from broadcast revenues. And especially for major football programs, these sports have become increasing professional enterprises. Universities pay coaches millions of dollars annually. Athletes enroll in schools where they can maximize their endorsement income. And the schools themselves readily shift athletic conferences to boost sports revenue.

Most of the biggest sports money makers are state-run universities that do not have 501(c)(3) status. But others, such as Duke or Notre Dame, are private nonprofits that do.

You might think sports broadcasting revenue has nothing to do with a university’s exempt purpose which is, remember, education. And thus, it would be taxable. But the IRS has been exceedingly flexible about this, and most college sports revenue remains tax-free.

Smith and his fellow lawmakers could do a real public service by thoroughly reviewing the tax-exempt status of all colleges and universities, especially their non-academic businesses such as sports and real estate development.

But selectively targeting schools because you don’t like their institutional views, or even because they don’t sufficiently police student comments you find offensive, is troubling. It endangers the free debate that already is at risk on many campuses and in civic life. And it is a strategy that might well backfire when political control of Congress changes, as it inevitably will.