States Must Spend Their Higher Education Funds More Wisely in the Future

The COVID-19 crisis should not obscure the need for major reforms in how states fund higher education

The COVID-19 pandemic has brought into sharp relief that higher education systems in most states were not prepared to deal with this crisis. Emergency measures are clearly needed now to replace government and tuition revenues lost as a result of the crisis. But government and institutional officials should be careful that any short-term fixes do not make it more difficult in the longer run to achieve much-needed reforms in how states finance higher education.

The widespread belief that states have been dis-investing in public higher education for many decades has fueled calls for making college tuition-free. The COVID pandemic has increased the volume on these calls. The belief that states have been chronically disinvesting has also led to many proposals for a federal program that would augment state funding under certain conditions. These calls for a federal bailout have also increased during the current crisis.

But the frequent assertion of state disinvestment has been overstated for several reasons discussed below. The more important issue going forward is to examine how existing state funding levels can be spent more effectively to meet the very real challenges that higher education faces. To ensure that state funding for higher education is financially sustainable in the future, states must be much smarter in how they spend their higher education funds.

There are at least three reasons to question the assumption of chronic state disinvestment. First, the robust growth in public higher education since the end of World War II would have been impossible without sustained high levels of state and local funding over an extended period of time. The fact is that state and local funding for higher education peaked in real terms in the aggregate in 2007 before the advent in the Great Recession and per student in 2000 (as shown in the graph above).

Second, while the average student share of the costs in spending in public colleges has reached 50 percent, when out-of-state and international students are excluded from the calculation, the share of costs of public higher education borne by state residents is 40 percent.

Third, the notion that overall resources for public institutions have fallen over time is just incorrect, as tuition revenue growth has more than offset the drop in state appropriations over time in real terms, as the chart above also shows.

Moreover, even if the student share of the costs rose more reasonably — to, say, one-third, as two national commissions recommended in the 1970s — state funding should have declined in real terms as the student share grew to reflect the private benefit of public higher education. Indeed, it would have been foolish for states to maintain their past level of funding as tuition increased reasonably, because it would have meant that public institutions would have been too flush in resources.

The release of the State Higher Education Finance (SHEF) 2019 report unleashed a new round of debate about state disinvestment. The summaries of the report’s findings have focused on the fact that state funding per FTE student when adjusted for inflation was lower now than it was in 1980.

Often lost in that debate, however, is the underlying reality that states and localities spend a lot of money in support of public higher education. According to the SHEF report, total state and local support of public higher education institutions and students in 2019 was more than $100 billion for the first time. This spending was 20 percent greater in real terms than what was spent by states and localities on higher education twenty years ago and 80 percent higher than forty years ago. Spending per FTE grew much more slowly because public sector FTE enrollments grew by 60 percent since 1980.

When tuition revenues net of aid of $75 billion are added to the mix, total educational resources available to public institutions were more than $160 billion in 2019, roughly $15,000 per full-time-equivalent student. These are among the highest funding levels for public higher education in the world.

It is also the case that most states over time have tended to focus their higher education appropriations more on meeting the financial needs of institutions than those of students. Typically, a state’s funding process begins by considering what represents full funding of institutions and then to what extent it is possible to meet those needs. State funding of student aid tends to be a residual decision once most other funding decisions have been made.

One result is that tuition levels at public institutions have shot up over time -especially when state funds are curtailed during recessions - and student aid gets short shrift in the funding process. Another reality is that enrollments tend to increase the fastest during recessions, especially at community colleges and graduate programs, as job market opportunities dry up. That helps to explain why state funding per student in real terms declines the most during recessions as the boom in enrollments generally outpaces the capability of states to support public higher education. For example, one-half or more of the decline in state funding per FTE between 2008 to 2013 was a function of rapid recession-induced enrollment increases.

Another major problem with the funding processes that exist in most states is that they tend not to encourage key policy goals such as efficiency, equity, growth, and degree completion. Most state funds, instead, are directed to the institutions with the most resources, and meeting the needs of disadvantaged students is typically under-emphasized. States also are often reluctant to share in the funding of growth in enrollments, relying instead on tuition and other student-paid fees to pay for that growth. Moreover, the funding process in most states traditionally favor enrollment over completion.

The Need for Smarter State Policies

Smarter state policies are urgently needed to mobilize the already high levels of public investment in public higher education to meet the very real challenges that face the sector. Such challenges include: exploding college charges; excessive reliance on loans; underinvestment in vocationally-oriented programs and apprenticeships; chronic equity gaps in participation, completion, and attainment; and concerns about quality and relevance, including modest degree completion rates.

The first step toward smarter policies is for state policy makers realistically to assess their situation, asking questions such as: What are the demographics within the state? How fast is demand for higher education likely to grow over time, or will the number of graduating high school students be falling? How strong is the private sector in the state? How much of projected demand are public institutions capable of providing? What is the quality and relevance of what currently is being provided according to objective measures?

The second step is to revise existing policies to meet the pressing challenges. To start, states should focus on making public higher education more affordable to a broad range of their citizens, especially those who lack the resources to go to college without financial help. To do this, public tuition in the future should be tied to the average family’s ability to pay, as measured by a share of the state GDP per capita. To be most effective, states should set a range of tuition as a share of state GDP per capita, and then allow institutions to decide what share of GDP per capita to charge their students. The tuition should also vary by institution and program; those institutions and programs of greatest demand and highest quality should charge a higher percentage of GDP per capita than those of lesser quality and in less demand.

The trick is for states to set realistic and reasonable limits on how high tuition could be set as a percentage of GDP per capita and to “claw back” a portion of the tuition collected above the base so that incentives to raise prices are mitigated. Another critical ingredient to make this work is for states to provide sufficient funding to ensure that enough aid is available to cover the full cost of tuition and fees for students from families with below-average incomes.

These approaches, taken together, have a symmetry that would produce much better results. The higher that institutions set their tuition as a percentage of GDP per capita, the less that states will need to spend to cover the full costs of providing the education at that institution. But for institutions charging near the top of the range, the states would also need to provide additional financial aid as there will be more students at those institutions whose families lack the resources to pay those higher charges. Conversely, for institutions that decide to set their charges at the lower end of the acceptable range, the state would be responsible to provide more institutional funding.

Together, these policies typically would lower net state funding requirements as the reduction in institutional subsidies would more than offset increases in state financial aid. For this approach to work well, it would also be essential for the federal Pell Grant program to be redesigned into a program that meets the non-tuition costs of attendance for students with limited family resources.

Recommendations to Improve Efficiency and Equity

States should also revise how they allocate funds to public institutions in ways that place greater emphasis on meeting the goals of making those institutions more efficient and the family income distribution of students more equitable. These changes include:

To make sure that all students are college or career ready, states should reallocate funds toward community colleges and other more vocationally-oriented programs, such as apprenticeships. Such a shift in how state funds are allocated would also recognize that the most direct and effective way for states to help unbend the higher education cost curve is to reallocate funds to those institutions and programs that tend to spend less per student than most public four-year institutions.

In addition, states should be willing to join with the federal and local governments in moving to a performance-based system for students taking remedial courses. In refinancing remediation, students would not be charged tuition nor be allowed borrow to pay for these courses. Instead, the various providers of remediation would be paid based on how well they raise the basic skills of the students taking those below college-level courses.

To help assure that all qualified state residents have access to public higher education, states should establish a full funding compact with all public institutions within the state. Under such contracts, public institutions that enroll target numbers of state residents would be assured of full funding through a combination of state appropriations and tuition and fee revenues. As long as those enrollment targets for state residents are met, institutional officials would then be free to decide how many non-residents to admit.

To encourage public institutions to grow beyond targeted enrollment levels, states should carve out a portion of the core grant and make it into a state-funded fee that is uncapped with regard to resident enrollments. Around the world, there is a question about whether governments are willing to help fund growth in enrollments or to have institutions rely solely on tuition and fees to cover the marginal costs of growth. Creation of a government-paid fee in the U.S. would mean state taxpayers would share in paying for this growth.

To encourage greater efficiency, allocations to institutions should be based on normative costs — -what “ought” to be spent per student in different fields — rather than the systems in most states that rely on institutional reports of how much they actually spent. Colleges and universities tend to exaggerate what they spend per student in reporting to state governments. A number of countries around the world use normative costs in their funding processes to deal with this possible discrepancy between actual and estimated spending.

To reduce the effect of the cyclicality of state funding, states should establish rainy day funds to insulate themselves from recessions, when state funds for higher education tend to evaporate.

To improve degree completion rates, states should allocate some of their funds based on the number of degree recipients rather than enrollments. And to improve the completion rates among disadvantaged students, states should appropriate resources to public and private institutions based on the number of state-resident Pell Grant recipients they enroll, transfer and/or graduate.

The proposals described here, taken together, would not require more funding than the $85 billion that states and localities currently spend to support public higher education institutions and students. The more that institutions charge for tuition as a share of GDP per capita, the less the states would need to pay to institutions but they would have to allocate more to student financial aid. The resulting net reduction in state funding requirements would allow states to direct more of their appropriations toward community colleges and apprenticeships, as well as to reallocate funds among four-year institutions within existing funding levels.

In sum, getting states on the right track with regard to higher education funding does not require radical approaches like making public colleges and universities tuition-free — which likely would only worsen the inequities that already exist. But it does require states to be much smarter in allocating the funds they already spend on public higher education to meet key challenges. The current COVID-19 crisis makes this longer-term imperative even greater.

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