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Business Officer Magazine

Down, But Not Out

Pummeled by repeated cuts in state funding, public institutions are slowly getting back on their feet after the longest-recorded postwar recession.

Catalyst for Change - The Economic Downturn Reshapes Higher Education

By Sandra R. Sabo

*In his two decades at Clemson University, Clemson, South Carolina, Chief Financial Officer Brett Dalton has experienced several economic setbacks, including the post-9/11 downturn and the burst of the tech bubble. But he finds the most recent recession, which came to a head in September 2008 with the near-collapse of the U.S. financial markets, unprecedented in Clemson’s history.

“We went back in the archives to the founding of the university in 1889 and could not find a similar period of significant revenue loss,” says Dalton. “Even in the Great Depression, we didn’t see such a deep and sudden decrease in revenues.” Specifically, South Carolina has reduced its recurring appropriation to the university from $165 million in FY09 to $91 million—a 45 percent cut in the last two years. Another 10 to 15 percent cut looms in FY12.

Like most states—with the possible exceptions of mineral-rich Wyoming and North Dakota—South Carolina simply doesn’t have the general operating funds it once did. Nationwide, sales tax receipts are down because of weak retail sales; higher unemployment and lower interest rates translate into less income tax revenue. Data collected by the Washington, D.C.–based National Association of State Budget Officers (NASBO) show that states reported an unprecedented year-over-year decline in spending for both FY09 and FY10.

“This downturn is not only the longest-recorded postwar recession but also broader than previous ones, in terms of geography and sectors,” notes Scott Pattison, NASBO’s executive director. “This time, every state has been affected and every sector has been hit—banking, real estate, autos, retail, you name it.” And the longer and broader the recession, he adds, the longer the recovery time.

No Relief Yet

Most economists pinpoint December 2007 as the beginning of the recession and agree it ended last September. The end, however, is not yet in sight for state governments, whose revenue collections will lag any uptick in economic activity.

To further complicate the budget situation, the availability of federal stimulus funds will expire by December. The two main components of the federal stimulus package—Federal Medical Assistance Percentage and the State Fiscal Stabilization Fund—collectively provided states with more than $130 billion in budget relief. Every $1 in stimulus funding that a state received meant $1 less in tax increases or budget cuts. Practically speaking, the funds simply delayed the inevitable.

“States patched their budgets with federal stimulus aid, which will soon disappear, withdrawals from reserve funds, and tax increases. But they have a big hole to fill for 2010–11 and, unless there’s a dramatic revenue recovery by next spring, 2011–12 will be a tough budget year as well,” says Donald Boyd, senior fellow at the Nelson A. Rockefeller Institute of Government at SUNY Albany.

The Oregon University System, for example, received $69 million in stimulus funds for the 2009–11 biennium. Without those funds—used primarily to minimize layoffs and hold down tuition increases—the system’s $807 million appropriation from the state would have dropped to 
$740 million. Even with the federal funds in the budget mix, the state still cut 9.6 percent from the previous biennium’s appropriation, reports Jay Kenton, vice chancellor of finance and administration for the Oregon University System.

Pennsylvania State University “benefited substantially” from stimulus funding in FY10, according to Albert Horvath, senior vice president for finance and business/treasurer. The federal funds essentially restored the $19 million Penn State had cut the previous year when the state rescinded 6 percent of the university’s approved appropriation.

“Today, in raw numbers, our appropriation from the state is pretty close to what it was in 2001. Of course, we’ve lost significant ground because of inflation and increased expenses,” says Horvath.

The state appropriation represents about 8 percent of Penn State’s total budget. In FY10, the university waited more than six months to receive those funds, thanks to a protracted budget battle within the state legislature.

“Fortunately, we had anticipated some problems,” says Horvath, “so we budgeted conservatively and managed our cash to ensure we wouldn’t have to take any draconian measures.” As luck would have it, Penn State had planned for six months without receiving any state support—a worst-case scenario that became reality.

“The basic economic outlook in Pennsylvania isn’t improving quickly or substantially, and there’s no indication that stimulus funding will be extended,” he adds. “Since we don’t know what the future holds, we’re already thinking about how we might balance our budget in 2012 and 2013.”

Ups and Downs

“Today, in raw numbers, our appropriation from the state is pretty close to what it was in 2001.”

Albert Horvath, Pennsylvania State University

Looking ahead to the next biennium and foreseeing a sizable shortfall in Oregon’s revenues, Kenton anticipates a 15 percent reduction in 2011–13 funding for higher education. Yet at the same time, Oregon’s seven public universities are serving more students than ever, with overall enrollment up nearly 7 percent just between 2008 and 2009. Enrollment is projected to grow another 7 percent in 2010–11.

Similarly, dramatic enrollment growth within the University of Missouri System has coincided with large reductions in state support. At Missouri’s flagship campus alone, undergraduate enrollment has increased 32 percent in the last 10 years; graduate student enrollment has jumped 54 percent. For FY11, the 69,000-student system anticipates a 5.2 percent reduction in funding, to $428 million—less than its funding 20 years ago, adjusting for inflation.

“Even when we had to increase tuition in response to the reduction in state support, it didn’t affect our enrollment,” says Natalie “Nikki” Krawitz, vice president for finance and administration for the University of Missouri System. “Of course, those additional students have helped us generate additional revenue to make up the difference in funding. But the large number of students also puts tremendous pressure on our institutions at a time when we’ve had to reduce faculty and staff.”

Krawitz attributes Missouri’s record enrollments to simple demographics as well as the recession. “Public research universities are a good option for many students who might have opted to attend private institutions in a better economy. Even for out-of-state students, public institutions are a ‘good buy,’” she notes. In addition, the Missouri system’s four campuses have actively recruited more graduate students.

Clemson headed in the opposite direction. Although the university now receives nearly double the number of applications it did 10 years ago, its leaders decided to hold enrollment steady at approximately 17,500 students.

“The university adopted a vision to become one of the top 20 public universities in the nation, so the quality of our applicant pool has increased significantly,” explains Dalton. “In fact, many of South Carolina’s best students are now staying in state, whereas in the past we often lost them to other good engineering and science schools.”

Dalton credits the state government with creating a merit-based scholarship program that helps retain high performers. Students who meet certain criteria—including SAT scores, class ranking, and grade point average—may qualify to receive an annual scholarship ranging from $5,000 to $10,000, for use at either a public or private institution. 

Even though South Carolina has reduced direct appropriations to higher education to fund the scholarships, Dalton applauds the program, introduced about 10 years ago. He says, “South Carolina has shifted the funding model of higher education, putting the money in the hands of families so they decide which institution receives it.

“The scholarship program has increased competition and increased quality across the board,” Dalton continues. As an example, he says, Clemson is now more responsive to the needs of students and to the quality of services 
and programs they demand.

New Deals

Competing Priorities

In FY08, about 10 cents of every dollar (10.2 percent) spent by state governments went to higher education, according to the 2008 State Expenditure Report published by the National Association of State Budget Officers. This category includes financial support of public university systems, community colleges, and vocational education institutions.

Elementary and secondary education represented the largest single category of state expenditures (21.6 percent), followed closely by Medicaid (20.7 percent).

“Although many states have made significant cuts in K–12 education, it’s protected more than higher education,” which has its own revenue sources, says Donald Boyd of the Nelson A. Rockefeller Institute of Government at SUNY Albany. “What’s relentless, however, are the growing costs of Medicaid. Even as states have less to spend, Medicaid is taking more and more money.”

Dalton, however, is less enthusiastic about South Carolina’s regulatory environment, which he characterizes as costly and increasingly burdensome.

South Carolina takes a one-size-fits-all approach, making public institutions subject to the same oversight, reporting requirements, duplicative reviews, and regulations as state agencies in areas such as procurement, human resources, and capital projects. It doesn’t matter that Clemson derives only 10 percent of its support from the state, while the agencies receive 100 percent funding.

“Something that makes sense for the highway department doesn’t necessarily fit higher education,” says Dalton, explaining why Clemson has an ongoing initiative to educate state legislators about the need for regulatory reform. Because of the regulations, he notes, “We’re missing opportunities to save money, such as entering a purchasing consortium with other educational institutions.”

In Oregon, the university system is a state agency—something its governing board may want to change. “The board is looking at radically restructuring our relationship with the state, to potentially make us more like a public corporation or a semi-privatized entity,” explains Kenton. “This could be a controversial issue with the legislature, students, and the governor, as it would alter relationships that have been in existence for many years.”

Given its current status as a state agency, the Oregon University System has no control over the design of its benefits plans or the scope of benefit coverage. For instance, the state mandates 100 percent employer-paid health-care benefits that total $13,800 annually,―soon to increase to more than $15,000 annually―per employee, compared to a nationwide average employer contribution of $8,000 annually at most other institutions. With 13,000 benefit-eligible employees, the university system spends nearly $180 million per year just on health care. If Oregon spent what other states spend, the total would be $104 million per year.

The state also assesses the system $30 million every two years to cover overhead and administrative costs and has been generous with retirement contributions and salary increases. Such mandates—accounting for 83 percent of the system’s cost base—greatly restrict how and where the seven universities can allocate resources.

Any statutory change would require approval by the Oregon legislature, which currently has the authority to control the university system’s expenditures. That condition effectively limits tuition increases, which pleases the many politically active students in the state.

“Right now our governing board has the authority to set tuition, but the legislature has the authority to control our expenditures. It makes for an unusual dynamic,” says Kenton. It’s conceivable, for instance, that the governing board might approve a 10 percent increase in tuition only to have the legislature rule that the system could spend only half of that increase.

When Oregon’s legislature convenes next January, the university system may propose a new compact between the two entities. In exchange for a certain level of funding and increased flexibility, for example, the universities might agree to serve, graduate, and/or retain a certain number of students each year.

As Kenton explains, “We want to change the budgetary relationship and focus our conversations more on accountability and outcomes. If we didn’t perform to the expectations established, then we might not receive the same amount of funding the following year.”

Two years ago, the Missouri General Assembly passed a bill that capped tuition increases at public institutions at the rate of inflation. (The legislation was in reaction to large tuition increases in 2003 and 2004, when state support declined 15 percent.) In exchange, Missouri’s higher education sector reached an agreement with the governor to return to 2001 funding levels by 2011, without adjusting for inflation. With the 5.2 percent reduction in state support in FY11, this goal will not be achieved. 

The governor and higher education agreed to limit the reduction in state support to 5.2 percent in exchange for holding tuition flat in FY11. Both houses of the Missouri General Assembly recently approved a FY11 budget that supports this agreement. Krawitz notes, “The General Assembly was looking for reductions in funding everywhere. But lawmakers understood that if they cut more than 
5.2 percent from our funding, the tuition cap was off the table.”

Change in the Wind

“Institutions have to rethink some of the expensive aspects of what they do.”

Scott Pattison, NASBO

NASBO’s Scott Pattison expects more states to broker funding-related arrangements with their higher education institutions. Based on the data, he says, states simply won’t be able to spend as much, on average, as they have in past years. As their revenue decreases or remains flat, states will want to know how those scarce resources are being used and what they’re receiving in return.

“Many higher education institutions don’t seem to appreciate the degree to which they will have to make tough decisions and really do things differently,” says Pattison. “The model of how higher education has behaved fiscally in the past can’t continue; institutions have to rethink some of the expensive aspects of what they do, perhaps even their missions.”

The University of Missouri System has already accepted that challenge. It recently implemented the Accountability Measurement System, which articulates 80 measures related to five key areas: teaching and learning, research and discovery, service and engagement, economic development, and developing and managing resources. The numbers-oriented measures drill down into all processes and programs, such as total degrees awarded by level and ethnicity, average undergraduate debt burden at graduation, and total endowment per student.

Starting this December, each campus and the university hospital will annually report on performance and progress as compared to three-year targets (to be achieved by FY12). For additional comparison, Missouri will also report averages and “best in class” benchmarks from peer institutions.

Benchmarking of information technology, finance, HR, and procurement processes recently began; a review of all academic programs will take place as well. “We’re looking for big changes—ways we can improve how we deliver services, increase their quality, and possibly decrease costs,” Krawitz says. “We want to be accountable to the people of Missouri for what we’re doing.”

Looking to identify $10 million in annual cost savings and nontuition revenue, Penn State recently created the Academic Program and Administrative Services Review Core Council. The group—comprising faculty, staff, and administrators from the university’s 24 campuses—is looking for both long-term budgetary savings and short-term cuts so funds can be reinvested in areas that support Penn State’s latest strategic plan, completed in 2009. In addition to freezing salaries in FY10, Penn State has already implemented new medical benefits for retirees and is considering changes in health insurance benefits for current faculty and staff.    

“We’re submitting everything we do to an evaluation. That will help us decide whether we can improve upon the program or service and also continue to invest in it,” says Horvath, who chairs one of the council’s three subgroups. “The evaluation process is not purely focused on cost savings but rather on whether we are doing the things we ought to be doing—and doing them as well as we should.”

Free From Fear

Clemson also has a comprehensive effort under way to reevaluate programs, services, and priorities in light of the new funding climate. The president has challenged all academic and administrative units on campus to rank their priorities, identify potential improvements and reallocations of resources, and even rethink the work they do. When the eight-month-long process concludes next January, presumably with some significant recommendations for change, Clemson will update its comprehensive plan.

To ensure that this long-range planning took place in an environment free of panic, fear, and crisis, Clemson took aggressive steps in 2009 to permanently reduce costs. “In September 2008, even as the financial crisis was evolving, we established a budget strategies task force and started cutting rather than watching and waiting,” Dalton recalls. “We wanted to have a solid financial foundation in place by 2010 so we could plan in a methodical, thoughtful, and rational manner instead of being reactive.”

In 2009 Clemson reduced its institutional and related support costs by about 30 percent, while preserving investments in core academic programs. In fact, the university’s instructional budget increased that year. Among the cost-cutting steps it took, Clemson:

  • Suspended two major construction projects that already had cranes and work crews on site. (Neither has yet been restarted.)
  • Instituted a mandatory five-day furlough for all employees (“including the president and the football coach,” notes Dalton).
  • Liquidated the university’s motor pool and outsourced fleet operations.
  • Outsourced the university’s long-standing print shop and publishing operations.
  • Phased out one third of the university’s support for centers and institutes. Another one third will be withdrawn in each succeeding year, leaving the units to generate support through external funding by FY12.

Although Clemson had considered some of these changes before, says Dalton, “The recession certainly helped remove any reluctance we might have had to make them.” Taking these steps, he adds, freed the university to focus on making progress toward its vision, rather than continually worrying, “How can we keep doing everything the same way but with less money from the state?”

SANDRA R. SABO, Mendota Heights, Minnesota, covers higher education business issues for Business Officer.