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State Shortfalls Projected Despite Current Fiscal Prosperity

Higher Education Budgets Likely to Feel the Squeeze

February 2000

The National Center for Public Policy and Higher Education

In Brief

Key Issues
This Policy Alert summarizes the outlook for state finances and, in the context of the needs of other major state services, for state support of higher education. It is based on State Spending for Higher Education in the Next Decade: The Battle to Sustain Current Support, by Harold Hovey of State Policy Research, Inc. A version of this article appeared in State Government News (January 2000), a publication of the Council of State Governments.

Primary Finding
Stringent budget conditions lie ahead for states and particularly for higher education.

Key Findings

• Projected state revenues over the next eight years will not be sufficient to maintain current state services.
• Even as state revenues have increased overall during the past decade, the share of state revenues devoted to higher education has decreased.
• Just to maintain current services, state spending for higher education would have to increase faster than state spending in other areas.

Target Audience
State government leaders, particularly governors, legislators, executive and legislative staff, state fiscal and budget analysts, and state higher education officials; business and civic leaders; federal policy makers, both executive and legislative; and the higher -education community.

Downloading the Full Report
State Spending for Higher Education in the Next Decade can be downloaded from the web site of the National Center for Public Policy and Higher Education at: www.highereducation.org. Single copies can be ordered by faxing requests to 408-271-2697.

Forecasting Methodology
This report uses economic assumptions and empirical methods that are widely accepted in the public and private sectors. For a description of this methodology, please refer to the full report.

Introduction

Although many states -- and their higher education systems -- are now enjoying prosperous times, these conditions are not likely to last, according to recent projections prepared by Harold Hovey of State Policy Research, Inc. Even if states experience normal economic growth over the next eight years, the vast majority of states will find it impossible to maintain current public services within their existing tax structures.

Maintaining funding for the wide range of existing state services will place enormous pressure on state legislators to reduce higher education budgets. Recently, colleges and universities have done disproportionately well during prosperous times and disproportionately poorly in tight budgetary times. In addition, demographic and economic factors in most states will require that higher education actually do better than other public sector activities just to maintain current service levels in the future. Directing a greater share of state budgets to higher education would mean reversing trends of the past decade.

If economic growth is slower than "normal," if states reduce taxes, or if states increase spending in areas outside of higher education, then the outlook for support of public higher education will be even less favorable.

Impact on Higher Education

Fiscal Outlook for States
To maintain current service levels, state and local governments will need to increase spending by slightly more than the percentage increase in the total personal income of all Americans. This increase in spending will allow for inflation, for population growth, and for maintaining constant services per unit, such as teacher/ -student ratios.

The Problem: State revenues will not increase as fast as personal income.
Under current tax policies, state and local revenues will not grow as quickly as total personal income. This is a well-known -problem that is largely the result of states' reliance on sales taxes and fees. "Every growth of 10% in personal income," Hovey writes in the full report, "is associated with growth of about 9.5% in state and local tax revenues."

The Result: Projected state revenues will not be sufficient to maintain current service levels.
"With revenues growing more slowly than personal income and outlays growing faster," Hovey reports, "state and local governments will have a structural deficit in funding current services. This mismatch between what would be needed to continue current programs and revenues from current taxes is about 0.5% a year. That is, to maintain current services, state and local governments nationwide would have to increase taxes by about 0.5%. Alternatively, they could maintain current tax systems and keep budgets balanced by holding spending growth to about 4.5% annually rather than the 5% needed to maintain current services."

By year eight, the structural deficit will average just less than 4% nationwide, but will vary depending upon the state (see Table 1). Even without a major economic downturn, 39 states will experience gaps between the cost of maintaining public services now in place and the revenues they can expect under current tax policy. Largely due to the robust national economy, this problem has not been obvious recently, but will become more evident in the next few years.


The Trend: Even as overall state revenues have increased, the share of state revenues devoted to higher education has decreased.
"Over the past decade," Hovey reports, "the percentage increases in state support for higher education have been smaller than the percentage increases in total state budgets.... In other words, higher education isn't competing successfully with the attractions of other forms of state spending."

The Projection: In order to maintain current services, state spending for higher education would have to increase faster than state spending in other areas.
Whereas total state funding for all services will need to increase by about 5% annually to maintain current service levels, state funding for higher education will need to increase by about 6% to maintain its current service levels largely due to enrollment increases. This means that even if states were not facing structural deficits in reaching the 5% annual growth in revenues, the percentage of state funding devoted to higher education would need to increase annually in order for higher education just to maintain current services. Table 2 provides a breakdown of the "annual advantage" needed for each state to maintain services for higher education.

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 recessions. During recessions, states often are caught with their budgets hugely out of balance.

When that happens, states tend to cut higher education spending more severely than they decrease spending for other programs, since higher education typically represents the largest discretionary spending item in state budgets. For the past quarter century, the pattern the states have followed in times of economic hardship has been to cut higher education budgets and raise tuition sharply (or allow colleges to raise tuition).

Moreover, in the current environment of generous appropriations for higher education, governors and legislators have exerted little pressure for efficiencies or cost containment in public colleges and universities. As a result, the recent increases in state support of higher education reflect only the standard responses to extraordinarily strong fiscal conditions. These increases "will disappear," Hovey concludes, when the "fiscal conditions disappear. Both will disappear soon."

Table 2 projects the percentage increase in state spending needed to maintain current services. The right two columns show the projected increases in state and local spending needed for all programs and for higher education over the next eight years. The "Annual Average Advantage for Higher Education" shows the "extra" percentage growth needed for higher education annually. Positive numbers in this middle column mean that in order to maintain current services, these states will need to increase spending faster for higher education than for other programs. States with negative numbers will be able to maintain current services by increasing spending more slowly for higher education than for other programs.

About the Author

Harold A. Hovey, who passed away in late 1999, published extensively on issues relating to local, state, and federal fiscal policy and management. He was president of State Policy Research, Inc., and editor of State Policy Reports and State Budget & Tax News. His previous positions include director of finance for the State of Ohio, budget director for the State of Illinois, senior fellow for public finance at the National Governors' Association, and head of the Public Policy Economics Division at the Battle Memorial Institute.

For over two decades Mr. Hovey consulted with the National Conference of State Legislatures and/or the National Governors' Association. His federal clients included the U.S. House Budget Committee, the General Accounting Office, the Office of Management and Budget, the Congressional Budget Office, and the Departments of Education, Health and Human Services, Housing and Urban Development, Transportation, and Treasury.

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© 2000 The National Center for Public Policy and Higher Education