States Must Reform How They Fund Colleges

Any short-term fixes to address the current crisis must not obscure the continuing need for longer-term changes in how states finance public higher education, argues Arthur M. Hauptman.


April 16, 2020

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 during the crisis. The extent of the short-term challenges and activities in various states are outlined in a recent Inside Higher Ed article describing how many public institutions will face severe budget cuts in the coming months in response to the pandemic.

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 public higher education. And the need for longer-term reforms should be put into the context of the frequent assertion that states have been disinvesting in higher education for many decades.

The widespread belief that states have been disinvesting in public higher education has fueled calls for making college tuition-free, and the current crisis has increased the volume on those calls. The belief in state disinvestment has also led to many proposals for a federal program that would augment state funding under certain conditions. Such demands for a federal bailout have also increased during the current crisis.

But the frequent assertion of state disinvestment is overstated for several reasons I’ll discuss in this essay. 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 over the long haul, states must be much smarter in how they spend their higher education funds.

A Questionable Assumption

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 levels of state and local funding, which peaked in real terms per student in 2000 and in aggregate in 2007 before the advent of the Great Recession. Second, while the average student share of the costs in spending per student in public colleges has reached 50 percent, when out-of-state and international students are excluded, the resident student share of costs is probably below 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 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 would still 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 recent release of the “State Higher Education Finance 2018” report has unleashed a new round of debate about state disinvestment. Lost in that debate, however, is the underlying reality that states already spend a lot of money in support of public higher education. According to the report, states in 2018 collectively spent $75 billion in support of public higher education, including for student aid but net of sponsored research support.

When combined with local government funding of roughly $10 billion per year, that means total state and local support of public higher education institutions and students in 2018 was $85 billion  --  28 percent more in real terms than what was spent a quarter century ago. When tuition revenues net of discounts of $75 billion are added to the mix, total educational resources available to public institutions were $160 billion in 2018, 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 in public institutions 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 during recessions as the boom in enrollments generally outpaces the capability of states to support public higher education. Roughly half of the decline in state funding per FTE between 2008 to 2013 was a function of rapid recession-induced enrollment increases. (And the fact is that states that respond to funding cuts by increasing enrollments -- thus providing more access -- look worse in terms of funding on a per-student basis than states in which enrollments are cut to maximize resources per student. Which states do we want to reward?)

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

The Need for Wiser State Policies

Smarter state policies are urgently needed  -- those that 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? Is demand for higher education likely to grow over time, or is the number of graduating high school students 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. 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. States should set the shares of state GDP per capita within a range, and institutions then would be responsible for deciding what share to charge their students. The expected result is that tuition will vary by institution and program, with those of greatest demand and highest quality charging a higher percentage of GDP per capita than other institutions.

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 at 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 such higher charges. Conversely, for institutions that decide to charge tuition at the lower end of the acceptable range, the states would need to provide more institutional funding. But the amount of state student aid funding required would be less.

Together, these policies would lower the net state funding requirements as the reduction in state operating subsidies would be greater than the 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 nontuition 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 equitable. These 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 funding allocations 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 the federal government in moving to a more fair and equitable performance-based system for students taking remedial courses. 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 be free to decide how many nonresidents 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 rely solely on student-paid fees to cover the marginal costs of growth. Creation of a government-paid fee in the U.S. would mean that state taxpayers would share in paying for this growth.

To encourage greater efficiency, states should allocate resources to institutions based on normative costs -- what “ought” to be spent per student in different fields  --  rather than the current systems in most states that rely on institutions’ reports of how much they actually spent. Colleges and universities can 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 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 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 imperative even greater.


Arthur M. Hauptman is a public policy consultant specializing in higher education finance issues. He can be reached at [email protected].


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