Willie Sutton and Greg Mankiw

by Russ Roberts on May 20, 2008

in Education, Politics

The Boston Globe reports (HT: Greg Mankiw) that politicians in Massachusetts have proposed a 2.5% tax on university endowments that exceed $1 billion. The argument:

"When is a nonprofit not a nonprofit because of the wealth they are
acquiring?" said Representative Paul Kujawski, a Democrat from Webster
and chief backer of the legislation.

"It’s mind boggling that one
entity not paying taxes has $34 billion. How do you justify that?" said
Kujawski, who serves on the influential House Ways and Means Committee.
"When people can’t afford to live. How do you justify not taxing them?"

There are two theories of economics to explain what government does. The first is the market failure argument–government exists to correct the failings of the market where "market" means the things that people choose for themselves. Examples include providing public goods, correcting for externalities, solving problems of imperfect information, and lately, making the distribution of income more just or equal.

Representative Kurajawski is claiming that inequality justifies taxing Harvard and using the funds to help poor people.

Then there is another theory of government. The fancy name is "public choice theory." But let’s call it by a simpler name–the Willie Sutton theory. When asked why he robbed banks, Sutton replied because that’s where the money is. In the Willie Sutton theory, the market imperfection arguments provide cover for the essential task of government in the eyes of politicians–taking money from A to spend on B.

The Globe story actually opens with the Willie Sutton explanation:

Massachusetts lawmakers desperate for additional revenue are eyeing the
endowments of deep-pocketed private colleges to bolster the state’s
coffers by more than $1 billion a year, asserting that the schools’
rising fortunes undercut their nonprofit status.

If you think most of what government does is to correct imperfection of private choice, then you tend to favor larger government. Those of us who favor smaller government tend to think of Milton Friedman’s observation that you spend your own money on yourself pretty carefully. But you’re pretty careless when you spend other people’s money on other people. So even if politicians are motivated to correct market imperfections, they will tend to do it poorly. But in the Willie Sutton theory, politicians are really spending other people’s money to benefit themselves–using that money to buy love, attention, campaign contributions and votes.

Of course, there is overlap. Sometimes, politicians buy love and votes by correcting market failures. Or by at least trying to correct market failures. But too often, they’re just using the language of market failure to act like Willie Sutton. If you worry, as I do, about this latter tendency, the road to a better life is to limit the power of government by changing the constraints that politicians face, rather than trying to elect wiser, kinder people. The biggest determinant of the quality of public policy is the quality of the constraints on politicians not the quality of the politicians.

And even if you accept the market failure argument, you have to worry about how legislation will act in practice rather than in theory. People respond to legislation. They don’t just sit still. In particular, people work pretty hard to avoid taxes. Here is Greg Mankiw’s suggestion for what Harvard might do to avoid the endowment tax:

1. Instead of expanding the university into Alston, Harvard could
create a second campus in another state. Call it Harvard South. (Put it
in a better climate than Boston, and I would be one of the first
faculty to volunteer for the move.)

2. Transfer much of the endowment to Harvard South. Support Harvard North by slowly selling off land in Massachusetts.

3.
Eventually, make Harvard South the main campus, and Harvard North the
satellite. If Massachusetts state lawmakers remain hostile, close
Harvard North down entirely.

Greg, I want to nominate Fairfax, Virginia for the location of Harvard South. But feel free not to wait for the legislature to provoke you. Come South on your own—we have a much better climate than Boston. I’ll talk to my colleagues and see what we can do.

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{ 15 comments }

James Miller May 20, 2008 at 12:58 pm

If a State already had a corporate income tax would you support the State giving a tax exemption to a politically favored set of corporations?

I wrote about this topic for Inside Higher Ed.

http://www.insidehighered.com/views/2008/05/19/miller

Libertarian May 20, 2008 at 1:02 pm

"It's mind boggling that one entity not paying taxes has $34 billion. How do you justify that?" said Kujawski, who serves on the influential House Ways and Means Committee.

If a non-taxed entity is becoming wealthy, doesn't that seem to be an excellent reason NOT to tax everyone else as well? But no, the politician wants his money, and wants to tax/punish everyone equally. BTW, any bets on how long the rate will stay at 2.5%?

Lee Kelly May 20, 2008 at 1:43 pm

Excellent weblog entry.

There are many pressing social problems which need to be solved; poverty, crime, inequality, racism, climate chaos, sexism, war, corruption, etc. It is of the utmost importance that we elect officials who we can trust, of good intentions and willing to fight the in the corner of the people against corporations and their corrupting influence.

To achieve this end, I propose that the powers of government are to be expanded, so that our elected officials can fight the problems which plague our society more efficiently, unhampered by the constraints, limits and restrictions imposed by the constitution.

It is undemocratic for those we elect to enter office unable to fulfil their promises to the electorate because of antiquiated constraints upon their power. These laws do nothing but limit our ability to enact urgently needed reforms, desperately needed for the good of society.

The market has been shown to fail time and time again, bringing us catastrophic depressions, rampant inequality, poor haelthcare, materialism, selfishness, and a pervasive culture of greed which is undermining society at its most fundamental level. The situation might have been far worse but for government, protecting the rights of the little guy and averting the worst of capitalism's inherent cycle of prosperity and depression.

It is time that we stopped listening to the libertarians, anarchists, minarchists, or whatever they call themselves now. It is clear that they are in the pocket of the corporations, out the pepetuate the system which we have and tolerate the widespread social problems which it breeds, motivated by selfishness and a quasi-mystical faith in "the market".

There needs to be urgent action! There needs to be change. If government is to achieve these ends that we expect it to, then more power is required, higher taxes and more expansive social programs. The anarchy of the market brings with it disorder, and it is about time that we again made this society roderly, civil and safe for our children and their children.

Randy May 20, 2008 at 2:31 pm

Good point, Lee Kelly, and as the structure of the current government is also a great hindrance to bringing about the needed change, I propose that it be replaced with an enlightened despotism.

Inbolgnito May 20, 2008 at 2:37 pm

Alternatively — move Kujawski to Fairfax ?

John V May 20, 2008 at 3:38 pm

One of the best entries I've seen, Dr. Roberts.

And to the politician that thinks like this:

"When people can't afford to live. How do you justify not taxing them?""

Before he/she goes into more "bright ideas" about how to solve the problem of people not being able to afford to live, perhaps he/she should take a step back and find out where previous bright ideas are contributing to that problem slowly begin dismantling them, cleaning them up and changing them. That should keep him/her busy for a few hundred years…

John V May 20, 2008 at 3:40 pm

Lee Kelly,

LOL. Good one.

drtaxsacto May 20, 2008 at 7:59 pm

This is what I said yesterday at http://drtaxsacto.blogspot.com/2008/05/taxing-harvard.html

Taxing Harvard
Like many other states, Massachusetts has a long term budget problem. That encouraged one legislator to argue that a way to solve the state's budget problem is to tax higher education endowments that exceed a billion dollars. Representative Paul Kujawski said "When is a nonprofit not a nonprofit because of the wealth they are acquiring? It's mind boggling that one entity not paying taxes has $34 billion. How do you justify that? When people can't afford to live. How do you justify not taxing them?"
The initial estimates of the revenues from this proposal are pretty large. The best estimate I have seen is that if implemented the tax would raise $1.4 billion, or about 5% of the state budget.

Inside Higher Education, had an article from a Associate Economics Professor at Smith who agreed with Representative Kujawski. But he went one step further, suggesting that while the tax would hurt the non-profit entities proposed to be taxed that a better way to do it would be by taxing tuitions. Piling on to this free-for-all is Wick Sloane, a former CFO at University of Hawaii and now at Bunker Hill Community College who said "These schools have generated huge cash flows but are not doing their civic duty."

The idea is bad tax theory and even worse social theory. On tax theory, there are two justifications for creating this new tax – the first is simple, the state needs the money and following the Willie Sutton theory of public finance the proposal comes out because it is perceived as an easy source of revenue. I can see a rationale for some Payments in Lieu of Taxes (PILOTS) which are collected by local agencies as an assessment of the cost of providing services to non-profits. But in the case of these universities using the logic of who provides what to whom, the state should owe them some of their tax revenues based on the contributions that these colleges and universities offer to the state. Is there any doubt that Massachusetts would be a lesser state economically if those colleges and universities were not there. The second tax theory notion in this proposal is some perverted theory of equity, we can allow non-profits to operate but they should always be below some theoretical level of resources, regardless of their scope or mission.

The social theory defect is even more compelling. Sloane's comment is absurd. How do you measure the civic contribution of a major university? Certainly not with an arbitrary scale based on total resources. Beginning with DeTocqueville our heritage recognized a vibrant non-profit sector as a way to provide public services from non-governmental sources. That offered the governmental sector competition, which is good. But it also allowed a variety of approaches to an area like education which offered benefits consumers of education and research. Indeed, places like Harvard generate huge cash flows. But they also offer huge public benefits. Who should measure that? If you think about it the managers and board of each civic institution should. These boards are charged with something that is hard to imagine in many public agencies, their role is to protect the financial and programmatic integrity in PERPETUITY. That is an order that the trustees of governmental programs, like Social Security, have not lived up to.

Paul May 21, 2008 at 7:55 am

Why is Harvard, the 'non-profit’ (wink-wink, nudge, nudge) untaxed, and the car repair shop is?

I associate the idea of Harvard as leftist, Democrat and long favoring the expansion of the state and it's taxes.

Why should Harvard escape the loving embrace of the state?

Russell Nelson May 21, 2008 at 1:19 pm

Lee: a roderly society scares me.

Lee Kelly May 21, 2008 at 5:32 pm

The speeling errors provide a greater sense of authenticity, I think.

Per Kurowski May 22, 2008 at 8:58 am

Russell Roberts "Those of us who favor smaller government tend to think of Milton Friedman's observation that you spend your own money on yourself pretty carefully. But you're pretty careless when you spend other people's money on other people."

We must note though that the above also sounds perfectly applicable to a university endowment with $34 billion.

vidyohs May 22, 2008 at 6:51 pm

I guess I'll show my ignorance but I always thought the legal and moral goal of a nonprofit was to show a zero balance at the end of the day.

In my ignorant state I always thought that if at the end of the day your balance sheet shows a plus figure then you have profit.

Legal gobble-de-gook may convert that concept with a legal ruling that "donations" and the resultant profit on investing those "donations" are not profit, but to this man's mind "a rose is a rose is a rose, and by any other name should smell so sweet (W.S.)."

How can any entity with a plus balance of 1 cent or 34 billion be a nonprofit?

Methinks May 23, 2008 at 4:57 pm

As I'm one of the taxpayers in the cross-hairs of ding-bats in congress, I tend to be permanently pissed off about the issue of taxation, full stop. I find it hilarious that these same leftist academics who mostly support an almost confiscatory tax scheme for the most productive members of society become enraged when their own university's endowments might be touched by taxation. Mostly, I've heard them use the same arguments that Milton Friedman would use to reduce taxation. Except, of course, in addition to all the logical arguments they insist that they're doing a lot of illusive and conveniently incalculable "social good". They're doing God's work over there at Harvard. Such saints. Really. What would we unwashed masses do without them?

Eduardo Prieto May 27, 2008 at 3:09 pm

I'm focusing more on the latter comment made:

"If you worry, as I do, about this latter tendency, the road to a better life is to limit the power of government by changing the constraints that politicians face, rather than trying to elect wiser, kinder people. The biggest determinant of the quality of public policy is the quality of the constraints on politicians not the quality of the politicians."

This stance sounds familiar to a contractarianistic approach to the Neoclassical Social Welfare Theorom (as oppose to it's current consequentialist approach), in which rather than focusing on the end results, we focus on the effects on INDIVIDUALS as INDIVIDUALS not as a WHOLE.

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