Why It’s Time to Re-evaluate “Profit” Status in Higher Education

Over the last 10 to 15 years, or so, almost any discussion about higher education policy has required that at some point, the legal profit status of the institution or institutions in question be revealed, followed by instinctive judgements about the institutions based on that tax status. Related to motives or mission or integrity, a non profit status is generally construed to be “good,” while a for profit status is generally construed to be “bad.” That basic assumption is questionable on its face, but setting that aside, any judgments based on tax status are becoming more and more tenuous.

There was a time long, long ago, when institutions of higher education fell into two simple camps relative to tax status: For profit and not for profit—and that distinction generally meant something. The non profits typically did all of the work associated with running a university themselves, their only business was higher education, and they rarely had significant “profits” at the end of a fiscal year. For profits were generally family owned and operated, with strong local relationships, and a market driven need for quality outcomes and compliance. The primary difference was not related to profit per se, but rather to which one paid taxes and how ownership was structured.

The reality of how a growing number of higher education institutions currently operate financially has changed so dramatically, that including profit status as a means of evaluating, validating, or regulating those institutions is probably no longer defensible. To start with, the largest and most “profitable” institutions in higher education today operate with a not for profit tax status. Non-taxable, elite university endowments alone are worth hundreds of billions of dollars. Non-taxable college and university real estate and other assets may be worth half a trillion dollars. And that’s just the balance sheet.

Operationally, the lines have been blurred for at least a couple of decades with hundreds of IHEs now in partnerships with for profit companies and a growing number of institutions actually functioning as venture capital investors in for profit businesses.

Many “not for profit” institutions of higher education have built high margin, tax-free revenue businesses, the proceeds of which are used for everything from incentive compensation to private equity investments to subsidies for unprofitable parts of their operations. Of course, all organizations, regardless of profit status, must generate more revenue than expense over time, i.e., must be profitable, and those who are more successful financially are able to confer more benefit to their stakeholders, which is a positive outcome for both non profit and for profit enterprises. The current conundrum around profit status is not even related to profitability. It is related to what organizations do with profits and how they are regulated relative to their legal corporate structure.

Ironically, IHEs with an actual, legal for profit tax status have never been less profitable and have been closing en masse. Those that do make profits, continue to pay federal and state income taxes on those profits (as well as local sales and often property taxes), while enduring additional regulatory burdens related solely to their tax status.

In what is probably the greatest irony of the for profit vs. not for profit debate, the most financially successful “not for profit” institutions today are making money using the same methods that “for profits” introduced into higher education decades ago—corporate partnerships, executive incentives, mass market programs, high-margin online programs, retail marketing, international and military students, spin-off businesses, equity investments, etc.—all while reducing costs with a for-profit-like expense model of contingent employees and outsourcing. Relatedly, the non profit fallacy is at the center of a growing divide between haves and have-nots within traditional higher education itself. While some non profit institutions have never been more profitable, with greater liquid assets, many others are facing existential financial stress–and hundreds will close over the next several years.

So, what does profit status really mean at this point? On the one hand, colleges and universities with a not for profit status have a significant financial competitive advantage over tax-paying, for profit institutions. They also have a reputational advantage, but without most of the restrictions, both regulatory and financial, that apply to those with a for profit tax status. If Arizona State or Southern New Hampshire or Purdue, for example, can take their profits and turn them into venture capital or establish revenue sharing agreements with for profit partners (or even acquire for profit partners, then shed the tax burden), is there a meaningful difference between them and IHEs that operate with a for profit tax status? Does it matter? Under what conditions would an institution with a legal not for profit corporate structure be perceived to have abused that status related to tax or regulatory obligations?

There is nothing wrong and a lot right with universities being entrepreneurial and with developing multiple revenue streams—in fact, it is necessary in today’s operating environment. On the other hand, not for profit tax status was never intended to be a competitive advantage in business. Moreover, it is a fair question to ask whether or not a non profit university should have access to taxpayer funded Title IV financial aid, legislative appropriations, and other government support while having zero tax obligations on their endowments, property, and other profits.

One might argue that institutions with a not for profit corporate structure are more likely to be student-focused or operate with higher integrity than those with a for profit status. However, if that non profit moniker has simply become a tax shield, while everything else about the operations says “for profit,” then maybe the tax status is meaningless for judging institutional mission and integrity as well. Moreover, if a public university invests in a for profit start up or acquires a business and it fails, whose money did they lose? If it succeeds, to whom do the profits belong? Private, not for profit institutions are a little more complicated, because they tend to receive much less taxpayer subsidy, but the richest universities by far also happen to be “non profit” privates.

The rationale for non-profit status to begin with is based partly on the notion that an organization on which such a valuable benefit is conferred, has some obligation toward the public good. It’s not that “non profits” can’t or shouldn’t be profitable. The idea is that if an organization is shielded from tax burdens and other regulatory obligations, that we should all be better off through a trade-off of sorts–the organization is afforded significant advantage, and in return, they make decisions that benefit society. That has been broadly true over most of the history of “traditional,” not for profit higher education, but if an institution with a tax free multi-billion dollar endowment is collecting taxpayer funded financial aid, then graduating students with unmanageable debt, while converting cash to venture capital, is that in the public good?

It would seem at this point that a better yardstick for validating the legitimacy of colleges and universities (and their taxpayer funding) would be achievement of agreed upon outcomes, rather than tax status. Those outcomes could be student diversity, student debt, retention, graduation and employment rates, socio-economic mobility after graduation or any number of potentially important objectives. That would also probably matter a lot more to students as well. Thinking way outside the box, imagine if an institution’s tax burden were based on achievement of those performance indicators rather than its status with the IRS!

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