Because colleges and universities serve a public purpose advancing higher education and promoting myriad forms of research they enjoy a variety of tax preferences. In addition to being exempt from paying federal income taxes, institutions of higher learning can accept tax deductible charitable contributions and use tax exempt debt to finance capital expenditures. It is the latter preference that the Congressional Budget Office (CBO) focuses on in this study, which was prepared at the request of the Ranking Member of the Senate Finance Committee. The law explicitly prohibits the use of tax exempt bond proceeds for the purchase of investment assets, a practice known as tax arbitrage; however, issuers of tax exempt bonds may use the proceeds for the purchase of operating assets while they simultaneously hold investment assets that provide a higher rate of return. To the extent that colleges and universities earn an untaxed return on investments that exceeds the interest they pay on tax exempt debt, they are benefiting from a form of indirect tax arbitrage.”
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