(2nd of 5 Daily Installments)
Tax Free Investment Income
Mercersburg's endowment grew to its current level through the steady addition of tax-deductible gifts and the reinvestment of interest, dividends, and capital gains - which are tax free to non-profits. In 1970, when I arrived to teach math, the school invested its entire $2 million endowment in bonds and cash - typical, at the time, of institutions with small endowments.
In the 70s and 80s, the more heavily endowed institutions grew bolder in their investing, moving toward stock-to-bond weightings of about 60:40. Led by the Ivies, they added a third type of investment, "alternative assets" in the 80s and 90s - a still more adventurous arena that includes hedge funds. From SY2008 to SY2012, the Ivies collectively outperformed both the 60:40 index and the 500-college endowment index, compiled by the National Association of College and University Business Officers. Mercersburg did even better (Appendix B.)
The Academy received an average $4.1 million in interest, dividends, and realized capital gains for the five years ending June 30, 2012 according to its IRS Forms 990. Individuals receiving such income were then being taxed on it by the IRS and the Commonwealth of Pennsylvania at 15% and 3.07%, respectively. Being exempt from these taxes saved Mercersburg an average $0.8 million per year for that period.
The years under study here, 2008 to 2012, include the worst part of the Great Recession. The stock market nosedived, as did interest rates, causing a nationwide drop in both charitable giving and investment income. In 2013 the top marginal tax rate increased by 460 basis points and the tax rate on investment income by 500, creating corresponding growth in the non-profit subsidies for giving and investment income. Thanks to a healthier stock market, the levels of giving and investment income have since rebounded, too, creating a rosier outlook for the future. Mercersburg began a $300 million ($694,000 per student) fundraising campaign in 2013 and announced a year later that it was two-thirds of the way to its goal.
No Sales Tax
Tuition, room, and board at all schools are exempt from state sales tax, even though they are clearly goods and services. At the 6% Pennsylvania rate, parents would otherwise have paid nearly $0.9 million in sales tax on fee income in SY2012.
Heating oil and gas, electricity, campus maintenance equipment, motor vehicles, and construction materials - most items purchased from Pennsylvania vendors - are also exempt from sales tax. If $2 million of the school's $27.3 million budget is a fair estimate of such in-state purchases, Pennsylvania's sales tax forgiveness would have been $0.1 million.
$1.0 million ($0.9 + $0.1) is not a big number in some quarters, but it looms large in the modest budget of a state which offers the same advantage to a great many non-profits.
No Property or School Tax
Non-profits pay no school or property tax in Pennsylvania or elsewhere. Mercersburg's IRS Form 990 lists the 2012 cost basis (less depreciation) of its property, accumulated gradually since 1836, at $73.0 million. Present value is much, much greater, of course - the most recent of 17 major campus structures alone cost $32 million when built in 2005. Using the more modest $73 million figure, though, and taxing it at the same 1% rate as other property in the county, the tab would have been $0.7 million.
This tax forgiveness is a big bite out of the budget of a school district still reeling from recession. Small wonder that municipalities across the nation are hungrily eyeing such lost revenue as a partial remedy to their financial problems.
Other Tax Expenditures
Mercersburg supplies free lodging and utilities to many faculty members who reside in student dormitories, and also to the Head of School. Faculty members and their families may also take three meals a day with students. The IRS calls these benefits "a condition of employment...for the convenience of the employer". They are free and they are tax-free.
If admitted, the children of faculty and staff may attend the school at no cost. The great majority, but certainly not all of these students, would be eligible for need-based, tax-free financial aid in any case.
The school gives "merit" awards" - tuition discounts - to encourage students with unusual talents to enroll, students whose parents' incomes may be high enough to make them ineligible for need-based financial aid. If applied only toward tuition, these awards are not taxable, but awards for room and board are, if the family has no financial need.
Although smaller and harder to quantify, these added benefits to employees are an important incentive in recruiting and retaining top teachers. They are not included in this tax expenditure calculation.
Added to the $2.9 million benefit from the charitable deduction, discussed in the 1st part of this 5-part series, the collective $2.5 million in the above items brings the subtotal of annual tax expenditures to $5.4 million. The next (3rd ) installment of this 5-part series examines the short- and (even better) long-term benefits to non-profits of the nation's Industrial Revenue Bond program.