Foreword
 
Executive Summary
 
Preface
 
The Outlook for State Finances
 
Prospects for Funding Higher Education
 
Fiscal Impacts on Higher Education Policy
 
Increasing Spending Outside of Higher Education
 
Cutting Spending Outside of Higher Education
 
Raising Taxes
 
Sensitivity Analyses
 
Participants, Symposium on Emerging State Policy Issues
 
Endnotes
 
About the Author
 
About the National Center

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State Spending for Higher Education
Page 5 of 14

Chapter Two: Prospects for Funding Higher Education

INTRODUCTION AND SUMMARY

Understanding the State Perspective
It is understandably difficult for someone oriented to a particular government-financed activity -- such as higher education, law enforcement, health care, or public schools -- to see beyond the needs for government support of that function. The usual approach from such a perspective is to ignore choices and problems associated with other functions, implicitly assuming that those with overall responsibility can and should make the adjustments -- in tax levels and funding of other programs -- that are necessary to provide appropriate funding for the activity in question. In this context, the discussion of baseline structural deficits is easily viewed as a problem that must be tolerated, but somehow should be dealt with by those who are supposed to deal with it, specifically those outside higher education.

Besides, projections like those presented above are dry as dust when compared with the appealing realities of any government function, such as higher education. Compared with such inviting concepts as broadening access and improving quality in higher education, funding current service budgets for health care or law enforcement sounds like a trade-off that somehow should be made in favor of the more attractive alternative.

A Native American saying asserts that you cannot know a person until you have walked in his moccasins. Most readers of this paper have lifelong careers in higher education, without the experience of having served in major elected offices, with no burning desire to do so, and with limited prospects for doing so even if they choose to do so. They haven't and will not walk in the moccasins of elected officials. For a short time, they must settle for a few written words that attempt to convey the perspective of elected officials.

Higher Education Funding Options
Three appendices to this report attempt to convey the perspective of elected officials by examining substantive and political arguments about tax increases and, program-by-program, arguments against cutting and for expanding major programs other than higher education. (Readers are presumed to be familiar with those arguments in relation to higher education.)

The gist of the arguments in each appendix and the basic conclusions flowing from them are summarized below. Chapter One, in projecting mild structural deficits in most states, indicates that there will be a widespread inability to fund current state and local services with current taxes. If higher education were to share proportionally in adjusting to this problem, it would:

  • not see expansion of spending patterns for any program except as financed by reductions in another program within total higher education spending by states, and

  • share proportionately in spending growth rates that average annually about 0.5% below the levels of total appropriations that are needed to maintain current services.

This conclusion could be avoided by two alternatives, both of which the appendices suggest are unlikely. First, state officials might raise taxes, but Appendix C provides many reasons that make this improbable. Second, state officials might favor higher education spending over other areas of spending by providing disproportionate budget cuts in other programs, but Appendix B indicates that this is unlikely.

State officials might, in fact, make the pain suffered by higher education proportionally greater than that of other programs. This would happen if they opted for the new initiatives in other programs described in Appendix A. Or higher education might suffer more than required to close the structural deficits because state officials insist on additional tax cuts.

The environment described in the appendices will make it difficult, particularly in some states, to achieve funding of current services for higher education. With a struggle just to maintain current service spending, increases above that level appear unlikely over any decade-long horizon. Specifically, it is likely that the fiscal environment for higher education in most states in the early 2000s will be significantly worse than it was in the late 1990s.

FUNDING CURRENT SERVICES

Amounts Needed
The baseline projections on which the discussion in Chapter One is based presume that state governments will continue to provide the same level of support for higher education as they have in the past. Specifically, this is defined as increasing funding enough to cover the expected increases in higher education enrollment with constant real (inflation-adjusted) support for full-time equivalent (FTE) students. To do this, state funding would have to cover per-FTE cost increases associated with general inflation and additional cost increases associated with presumed increases in higher education salaries equivalent to increases being experienced in the private sector.4 The net effect of these factors is that total state support needs to increase by nearly 6% a year in the baseline projections.

Implications of the Baseline for Higher Education Funding

If 6% increases are, in fact, achieved, state support of higher education would closely resemble the patterns now in existence. This, of course, is the intent of current service or baseline budgets.

Specifically, the total costs of higher education would rise about 4% per FTE student. The share of total costs currently paid by the federal government, state and local governments, and tuition would remain as it is today. Higher education tuition would thus be rising slightly faster than inflation, along with the funding from other sources of support for higher education.

SHIFTING SPENDING PRIORITIES TOWARD HIGHER EDUCATION?

National Situation
Over the past decade, the percentage increases in state support for higher education have been smaller than the percentage increases in total state budgets. The baseline projections imply that this situation will need to be reversed. Specifically, annual increases in state appropriations of about 6% would contrast with annual total budget increases of about 5%. They would exceed annual increases in elementary and secondary budgets of just under 5%. To fund the baseline, state elected officials would be in the position of having to defend an apparent priority for higher education spending -- as well as defending the apparent other priority implied by the baseline, Medicaid.

This development implies a significant shift in emphasis from what state officials have been doing over the past decade and from the near-universal statements about spending priorities in the 1998 campaigns. Many candidates talked about a priority for spending on education. For most of them this boiled down to K12 education.


State Situations
Individual states face dissimilar situations because of expected differences in the budget increases needed to maintain current services. These differences are caused by several factors, including projected increases in higher education enrollments and in the workload factors driving other spending. The differences among states are captured in Table 2. The right two columns of the table show the projected increases in total state and local spending needed to maintain current services over eight years, and the spending increases needed for higher education to maintain its current services over the same time frame. The "Annual Average Advantage for Higher Education" is derived by subtracting the growth in all programs from the growth in higher education, and then dividing by eight to give readers a feel for the annual difference.

Based on the national average, spending for higher education would have to increase 1% faster than total state and local spending (the higher education "advantage") if current services are to be maintained for all programs. As Table 2 shows, eleven states can cover current services by providing smaller increases to higher education than to their total budgets. These are primarily southern states that saw rapid growth in the 1960s and 1970s, resulting in enrollment bulges for higher education in the 1990s. In the next decade, higher education enrollments will be stable or declining while other portions of the population, particularly those over age 45, expand rapidly.

In a third of the states, current service spending implies providing for annual growth in higher education funding that exceeds by 2% or more the growth rates in total annual spending. This occurs primarily because those states, particularly those in the Southwest, are now feeling the impacts of higher education enrollment of their rapid growth in the late 1970s and 1980s.5

BASELINE IMPLIES TAX INCREASES IN MOST STATES

The Magnitude of the Fiscal Problem
To provide the level of funding for higher education described above, state officials will need to put themselves, in conjunction with local governments, in a position to fully fund their current service budgets. Nationwide this implies tax increases of about 0.5% a year. A few states would not require tax increases at all, while some others would require tax increases approximating 1% a year.

The baseline projections do not include the impacts of decreases in revenues because of recently legislated tax cuts. Many states have already enacted tax cuts that are being phased in over a period of years. These future cuts will cause budget shortfalls in these states to be larger than the shortfalls presented in the baseline projections. Nor do the baseline projections include the impacts of the many commitments made by individual state elected officials in support of tax cuts that have not yet been enacted.

In combination, these factors suggest that funding the baseline budgets of higher education and other programs implies substantial tax increases. The amounts vary by state. Each state will have somewhat different: (1) baseline budget shortfalls or surpluses, (2) already enacted tax cuts taking effect in future years, and (3) likelihood of enacting additional tax cuts in 1999. Summing these would imply tax increases by state and/or local governments during the early 1990s of as much as 1% a year in many states.

Obviously, state officials are unlikely suddenly to announce that they see a need to start raising taxes just because projections indicate future fiscal problems. Instead, the cyclical patterns that historically have brought about state tax changes reveal that tax increases must appear to be absolutely essential at the time. This dynamic is particularly germane because extraordinary economic circumstances can make state fiscal positions look artificially strong in good times, such as those of the late 1990s. In such an environment, state legislatures tend to expand state spending and cut taxes, while still producing balanced budgets -- but only so long as the unusually strong economic circumstances continue.

Fiscal Crises
If extraordinarily good times were followed by normal times, it might be possible for states to make fiscal adjustments in less than a crisis environment. However, extraordinarily good times are usually followed by corrections in the private economy called recessions. When these occur, states are usually caught in a situation where their budgets are grossly out of balance. Often state officials are slow to recognize the onset of recession. Because of the timing of legislative sessions and controversy over appropriate solutions, state legislatures are often slow to enact corrective measures once the problem has been recognized. As a result, the magnitude of corrections to maintain balanced budgets is often 5% or more. That is, the corrections imply a combination of spending cuts and tax increases amounting to 5% or more of total spending, often to be continued in effect for several years.

The crisis environment created by unexpected large budget gaps provides the political environment most conducive to state tax increases. Increases are presented as an alternative to such measures as laying off large numbers of state employees, mid-year cuts in school funding that would cause actions like ending extracurricular activities in public schools, mid-year increases in university and community college tuition, and the like.

Even in such a crisis environment, it isn't obvious that state elected officials will act to avoid these results. Their primary objections are likely to be: (1) concern over rising taxes, and (2) concern over the apparent priority being given to higher education over other competitors for funds.

LOOKING HARD AT HIGHER EDUCATION SPENDING

In the early 2000s, state elected officials will be facing structural deficits yet seeking to fund new initiatives in many programs (Appendix A). They will be confronted with difficulties in raising taxes (Appendix C) and cutting current services in other programs (Appendix B). In this context, at an absolute minimum, they and their budget staffs will be subjecting higher education to more scrutiny than in the recent past.

The underlying question about spending will be whether, at the margin, higher education spending is contributing more than spending at the margin in other programs. This question will be raised in a political dimension with the adverse electoral consequences of cuts in higher education compared with cuts affecting public schools, health care providers, and others active in state politics. The question will be raised in a substantive dimension with the values of improvements in higher education compared with the values of improvements in job training, preschool education, preventive health, and other programs.

One underlying question about financing will be whether raising revenues in the form of budgets that encourage university officials to raise tuition (or cut spending) are less painful than raising revenues in the form of tax increases.

CROSS CUTTING APPROACHES

Historically, elected officials have often found comfort in applying a logic equally to all program budgets. Critics can argue that such approaches ignore the relative merits of spending increases and the costs of spending cuts in each program and thus beg the issues elected officials are supposed to decide. A more positive view of the result is to say that elected officials often simply assume that the relative merits of increases and adverse consequences of cuts are about equal across programs, so adjustments associated with changes in state fiscal circumstances should be in roughly equal proportions.

The across-the-board approaches are particularly likely to be employed in situations where the complete state budget process cannot be used to set new priorities based on changed fiscal circumstances. Those situations arise when governors and/or legislative budget committees are charged with adjusting already enacted budgets to deal with unexpected fiscal difficulties.

Historically, the first signs that state budgets are unbalanced usually come during a period for which the current budget has been set, and thus needs to be trimmed in mid-year or in the midst of a biennium. Some of the across-the-board measures adopted in such circumstances have included:

  • Uniform holdbacks of appropriations, called pro-ration in some states, by which spending for each function is constrained to 1% to 5% below amounts appropriated;

  • Freezes on new hires and promotions;

  • Freezes on purchases of new equipment and renovation projects;

  • Elimination or curtailment of hiring of seasonal or temporary workers; and

  • Restrictions on travel.

As fiscal difficulties persist, the need to formulate new budgets with less total spending than required to maintain current services appears. Across-the-board approaches are often applied in this situation also. Some examples are:

  • Freezing spending by holding appropriations in the new budget to the dollar totals provided in the old;

  • Adjusting budgets only for changes in workloads (e.g., FTE student counts), thereby requiring state agencies and grantees to absorb costs of employee pay raises and inflation in costs of utilities and purchases; and

  • Across-the-board percentage reductions in total spending from a base of either the costs of maintaining current services or the previous year's budget.

While subject to the criticism that these across-the-board efforts are arbitrary, many elected officials are more comfortable with them than with more policy-oriented and less uniform sharing of fiscal pain among program clients and interest groups advocating various forms of spending. Public higher education in most states has seen these across-the-board policies at work in past periods of fiscal adversity and is likely to see them again in the early 2000s.

SINGLING OUT HIGHER EDUCATION FOR DISPARATE SPENDING CUTS

Over the past several decades, state budgets for higher education have reflected two major characteristics. First, the percentage of state spending devoted to higher education has been declining. Second, there have been fluctuations in higher education spending, changes that are linked to state fiscal circumstances.

The Balance Wheel Concept
The fluctuations in higher education spending stem from use of higher education as a "balance wheel in state finance."6 Typically, when state finances are strong, appropriations for higher education have risen disproportionately to appropriations for other functions. But current service budgets in higher educa-tion have been cut disproportionately when state fiscal circumstances are weak.

Selection as a balance wheel results from some perceived characteristics of higher education relative to other objects of state spending. First, higher education institutions have separate budgets with reserves of their own and perceived fiscal flexibility to absorb temporary fiscal adversity, unlike state agencies which do not have these features. Second, higher education is perceived as having more flexibility to translate budget changes into employee pay than state agencies, which are bound by statewide pay scales, and local education agencies, which are subject to collective bargaining and multi-year employee contracts. Third, higher education is seen as having more flexibility to vary spending levels (e.g., through changes in courses offered and class sizes) than most programs, which have spending levels that are more fixed. Fourth, in most states, higher education has the ability to maintain and increase spending levels by shifting larger proportions of costs to users by tuition and fee increases.

Temporary Cuts and Permanent Loss of Budget Share
Use of higher education as a balance wheel has probably been an independent factor leading to the reduction in higher education spending as a share of state budgets. Because the starting point for budgeting is the prior year, dispro-portionate spending constraints on higher education tend to be perpetuated as state financial circumstances improve.

However, there are other reasons why the higher education share of state spending has been declining. One major reason is totally independent of higher education or of current perceptions of higher education. Through the late 1980s and early 1990s factors unique to Medicaid and corrections were causing rapid annual increases in spending for those programs. Because "shares of the budget" is a zero-sum game, their gains had to come at the expense of shares of other programs. Viewing the same phenomenon another way, the baseline costs of those programs rose rapidly because of changes in federal mandates, workload (e.g., prisoners to be confined, parolees to be supervised, and Medicaid clients, particularly those in nursing homes), and cost factors (e.g., increasing complexity and cost of medical procedures). There were no comparable changes in higher education in most states.

Even with these explanations, it appears that higher education is doing worse in capturing growth in state spending that would be expected based on changes in objective circumstances alone.7 In other words, higher education isn't competing successfully with the attractions of other forms of state spending.

The critical question for many readers is undoubtedly whether these factors will continue to impact state support of higher education in the next decade.

The answer to this question cannot be known with certainty. The author's answer is YES. Absent any evidence of change, the author assumes that elected officials' attitudes toward the substantive and political merits of spending on various programs remains as in the past. With attitudes and decision-making procedures unchanged, and with the impacts of strong and weak state fiscal circumstances on higher education spending well known, forecasting state approaches to higher education spending becomes simply a matter of forecasting the state fiscal circumstances likely to prevail in the next decade.

Given the fiscal environment predicted in this paper for the next decade, the fiscal outlook for state support of higher education is not good from the perspective of advocates of increased state spending for higher education. Use of higher education as a balance wheel will continue. Higher education will likely share disproportionately in the adverse consequences of the structural deficits likely to become increasingly apparent in most states.

Put another way, the current relatively generous increases in state support of higher education do not reflect changes in patterns and practices in state budgeting. They only reflect the standard response to extraordinarily strong fiscal conditions. They will disappear when those fiscal conditions disappear.8 Both will disappear soon.

COULD THESE CONCLUSIONS BE WRONG?

The predictions of widespread structural deficits in state and local government throughout the next decade are the cornerstone of the conclusions in this chapter. Those conclusions are based on many factors, some more predictable than others. Appendix D discusses the sensitivity of the conclusions to various predictions and assumptions.

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