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Experts Say Impact of Endowment Tax on Harvard Investments Remains Unclear

Harvard Management Company
Harvard Management Company is housed in the Boston Federal Reserve Building.

Experts say the effect of the unprecedented federal tax on Harvard’s endowment remains unclear as the federal government continues to work out how the new law will be implemented, though it could potentially change Harvard’s long-term investment strategy if tax rates increase.

In December, Republican lawmakers passed tax legislation—dubbed the “Tax Cuts and Jobs Act”— which requires private colleges with endowments greater than $500,000 per student to pay a 1.4 percent tax on annual endowment returns. Harvard is one of 35 institutions that could pay tens of millions in federal tax under this new provision. Provost Alan M. Garber ’76 criticized the bill in a November email to Harvard affiliates, estimating that the University would have paid $43 million if the tax had existed in fiscal year 2017.

New York University finance professor David L. Yermack ’85 said there were “big unknowns” surrounding the tax bill as the Internal Revenue Service has yet to define how the law will be regulated.

If, for instance, capital gains are only taxed upon sale, Yermack said he would expect Harvard to do “much less high frequency trading” in order to avoid taxation.

“Until the IRS weighs in on this, we would not have a lot to go on in terms of what fraction of the profits of the endowment of any university might be taxed, let alone what might be exempt,” Yermack said. “Until they write the regulations and explain how they will regulate this, it’s anybody’s guess.”

The process of executing the new tax law, which Yermack called the “broadest tax bill in 30 years,” could take months to resolve—potentially years if a university challenges the legislation in federal court.

Business School Professor Luis M. Viceira said the 1.4 percent tax rate could affect how Harvard spends its money, but it is not likely to “make a huge difference” for the University’s overall investment strategy. Viceira warned, however, that the precedent the endowment tax sets could lead to longer-term consequences.

“Going down into the future, once you have started taxing returns on the endowment, the tax rate could go up,” Viceira said. “And if it does, it can start having a meaningful impact on how Harvard will think about investing.”

Viceira said if the endowment tax rate increases—up to 10 percent, for instance— the University will have “preference for securities that are tax efficient.” Harvard Management Company, which manages Harvard’s $37.1 billion endowment, would look for longer-term capital gains rather than short-term dividends.

“You will have a preference for not realizing short-term capital gains because they get taxed higher than long-term capital gains,” Viceira said. “You will have a preference for equities over fixed incomes because fixed incomes will be more heavily taxed.”

In an emailed statement, University spokesperson Vanessa McMillan wrote that the University is keeping close tabs on the situation.

“At this time, the University is evaluating the details of the tax law’s provisions, assessing the impacts of the new investment income tax, and developing an appropriate approach to implementation,” she wrote.

—Staff writer William L. Wang can be reached at william.wang@thecrimson.com. Follow him on Twitter @wlwang20.

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