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Business Officer Magazine

Redefining State Support

Public institutions are partnering in a variety of ways with state governments to formalize monetary commitments.

By James A. Hyatt

To mitigate this situation, some states and their public institutions have taken dramatic actions. Campuses in California have adopted partnerships or compacts with their standing governor to guarantee a minimum level of funding in exchange for a set of accountability or performance measures. In Virginia, recent legislation would grant public colleges and universities significant administrative and financial flexibility in return for integrated six-year academic and financial plans coupled with accountability and performance measures. Colorado has moved from incremental funding of its public institutions to a student-directed voucher approach. And Ohio’s Miami University has redefined the state’s role in funding higher education by implementing a scholarship program that essentially eliminates the distinction between in-state and out-of-state students by setting a single tuition rate but providing differential funding to state residents.

Developments such as those in California, Virginia, Colorado, and Ohio highlight key issues and challenges surrounding the creation of funding alternatives for public colleges and universities.

California: Compacts and Partnerships

During the early 1990s, California experienced a prolonged economic recession resulting in funding reductions and tuition increases for the state’s public higher education institutions. Although the budget reductions were extremely painful, one of the worst consequences of these reductions was the climate of uncertainty they created as to the ongoing level of state support. As a result, then-Governor Pete Wilson and the administrations of the University of California and California State University entered into discussion about how to create a funding compact between the state and its two university systems to guarantee a predictable level of state support.

The basic components of this funding compact included predictable general fund budget increases each year for the UC and CSU systems. Under the governor’s commitment, UC and CSU each would receive a 2 percent state general fund increase in FY 1995-96 and annual increases averaging 4 percent for the next three years. The plan also called for greater operating efficiencies, increased state funding for financial aid, and higher student fees. In exchange for a predictable level of funding, the two university systems also agreed to a series of performance and accountability measures. Among other measures, these included improving access to a quality undergraduate education, improving integration and coordination within California’s educational system, and meeting teacher demand and improving the quality of teacher preparation.

When Wilson’s second term ended in 1996, UC and CSU entered into a new funding agreement with Governor Grey Davis. Although termed a partnership rather than a compact, the elements of the agreement were the same. The two systems were to achieve productivity savings through increased use of technology and streamlined administrative practices to help fund chronic budget shortfalls in four core areas: building maintenance, instructional equipment replacement, instructional technology, and libraries. This shortfall was estimated at $150 million in FY98-99. For its part, the state would provide an increase of 1 percent above the prior year’s state general fund appropriation each year for four years, totaling $100 million toward elimination of the shortfalls. UC and CSU campuses were to achieve productivity savings of at least $50 million to eliminate the remainder of the shortfall by FY02-03.

For the first two years of the partnership, actual funding exceeded the terms of the agreement and significant funding was available for special initiatives. However, by FY04-05, the annual shortfall between what UC should have received and the amount it actually received approached $1.1 billion (see table).

Toward the end of Governor Davis’s first term, a major economic recession resulted in suspension of the funding components of the partnership and significant budget cuts. Although Davis was re-elected to a second term, a voter recall initiative in the fall of 2003 resulted in the election of Arnold Schwarzenegger. Following the election, UC and CSU entered negotiations to create yet another agreement (see sidebar, “California’s Partnership Terms”). As of September 2005, the terms of this new compact have held for both the UC and CSU systems.

Shortfall in University of California Partnership Funding ($ in millions)
2001-02 2002-03 2003-04
State General Funds UC Should Have Received Per the Partnership 3,423 3,702 3,980
Actual State General Funds UC Received 3,322 3,221 2,902
Annual Shortfall (with 20% cut in 2004-05) 101 481 1,078

Virginia: A Restructuring Resolution

California’s Partnership Terms

Terms of funding for the partnership between the state and the University of California (UC) and California State University (CSU) systems under Governor Arnold Schwarzenegger include the following:

  • Annual state funding growth of 3 percent for salary and other cost increases, growing to 4 percent annual growth in FY07-08.
  • Funding for an additional 5,000 students each year starting in FY05-06, which, after enrollment cuts in FY04-05, will put the university back on its original plan for accommodating enrollment growth over the course of this decade.
  • A further 1 percent annual augmentation for core needs, such as instructional equipment, instructional technology, building maintenance, and library materials beginning in FY08-09.
  • Undergraduate fee increases of 14 percent in FY04-05 and 8 percent in FY05-06 and FY06-07. Longer term, fees would go up no more than 10 percent per year, with UC and CSU keeping the revenue rather than backfilling state cuts. (Under the compact, fee increases would be indexed to per-capita personal income growth, but the governing boards could increase fees by up to 10 percent a year in compelling fiscal circumstances.)
  • A graduate fee increase of 20 percent in FY04-05 rather than the 40 percent originally proposed. Fees would increase another 10 percent in both FY05-06 and FY06-07, and UC and CSU will develop a plan for graduate fee levels over the longer term. UC will also develop a plan for professional school fees.
  • UC will reserve between 20 percent and 33 percent of new fee revenue for financial aid to preserve accessibility for students of all financial backgrounds.
  • Continued state support for the development of UC Merced.
  • Agreement by UC to use non-state resources to provide $12 million in support for K-12 academic preparation (outreach) programs, with additional state support to be determined through the annual budget process.
  • The Schwarzenegger administration’s support for future education bond measures providing UC and CSU with funding for facilities and infrastructure.

In exchange for these funding provisions, UC and CSU agreed to these accountability measures:

  • Meet the enrollment objectives of the master plan for higher education, assuming adequate state resources are provided.
  • Report to the state annually on a variety of student and institutional outcomes, focusing on demonstration of student success and efficient use of resources.
  • Preserve faculty workload policies comparable to those of other universities and continue to make the highest priority ensuring that students have access to the classes they need to graduate in a timely manner.
  • Expand efforts to improve the supply and quality of math and science teachers in California’s public schools to further bolster the state’s economic recovery.
  • Strengthen programs encouraging students to participate in community service.

Virginia’s higher education system has been chronically underfunded, currently by about $400 million annually. Higher education has carried the lion’s share of the budget cuts in the most recent recession and in the early 1990s. Tuition was constrained—either frozen or reduced—by the legislature for seven years. The net effect? Some institutions underpriced their product at the expense of quality and service. For instance, compared with its 23 public peer universities throughout the nation, Virginia Tech has the lowest overall cost to attend.

In Virginia, public higher education institutions are classified as state agencies, the same as corrections or transportation. Administrative and financial transactions at the state level are the same for colleges and universities as for other state agencies. Furthermore, all prior year fund balances for both state and non-state funds must be reappropriated at the beginning of each new fiscal year.

Beginning in the 1990s, institutions were successful in obtaining some decentralization authority for several administrative operations in finance, personnel, procurement, capital outlay, and real estate management. However, state administrative structures still significantly impacted the manner in which institutions ran their business operations and minimized the cost savings (capital projects) and human resource efficiencies (freedom from state personnel act) that could be realized.

During the 2004 legislative session, Virginia Tech, the University of Virginia, and the College of William and Mary proposed that each institution, and any others that qualify, be given increased authority and management flexibility for operations. Under the proposed new relationship—termed the Charter University Initiative—the three universities would remain public institutions with governing boards appointed by the governor, confirmed by the general assembly, and held accountable to the commonwealth. Charter legislation would enable qualifying institutions to use their own resources to solve persistent funding shortfalls. New financial resources could be applied to hire additional faculty members or address long-standing salary inequities and deficient operating budgets.

As part of the charter initiative, authorities and performance standards would be spelled out in the charters in much the same way that a municipality receives its governing authority. Charter universities would remain public bodies—political subdivisions—but not state agencies, and university employees would remain public employees. Charter universities would still be under the control of the many state laws governing education. For example, the state would still approve new degree programs and determine certain management standards. Governing boards would set tuition reflective of the state-determined “cost to educate” and relative to the market of peer universities.
Because of anticipated cost savings from greater management flexibility, the three universities that proposed the charter were willing to accept a smaller share of future higher education funds from the commonwealth. Other universities that opted for charter status would not be subject to this provision. 

As the charter initiative moved through the legislative process, it evolved into the Higher Education Restructuring Initiative. Factors affecting this evolution included obtaining legislative buy-in and support, communicating with constituent groups (faculty, students, staff, alumni and friends, parents, and community and civic groups), receiving buy-in from other public universities, and gaining the support of Governor Mark Warner. Under the new restructuring initiative, all public universities were eligible to participate if they met certain criteria specified in the act. The legislation also identified three levels of participation (see sidebar, “Virginia’s Restructuring Initiative”).

When the legislation was passed by the legislature and sent to the governor for signature, he decided to incorporate specific criteria in exchange for granting the requested administrative flexibility. Under the governor’s proposed bill, all institutions requesting Level One authority required their governing boards to pass resolutions and agree to the state’s ask, which identified the governor’s priorities, such as access to higher education and articulation agreements with community colleges. Furthermore, institutions that qualify for and seek Level Three status would be granted additional authorities and administrative flexibilities in the areas of financial operations, capital outlay, procurement, information technology, and human resources.

By November 2005, all of Virginia’s public higher education institutions, in conformance with the Higher Education Restructuring Act, will have submitted resolutions agreeing to the state’s 11 asks and will have submitted six-year enrollment, academic, and financial plans to the State Council of Higher Education for Virginia. In addition, institutions requesting Level Two authorities will have developed memos of understandings related to selected areas of operations, and Level Three institutions will have submitted management agreements that would grant additional flexibility in key administrative areas.

Colorado: Voucher Funding

Virginia’s Restructuring Initiative

Virginia’s Higher Education Restructuring Initiative identifies three levels of participation by public institutions.

Level One: In return for committing to meet stated objectives, institutions will receive some additional operational autonomy in procurement, personnel, and capital outlay.

Level Two: Any public institution may enter into a memorandum of understanding with the appropriate cabinet secretary or secretaries for additional operational authority.

Level Three: Institutions with at least a AA- bond rating (un-enhanced) may seek additional autonomy through a management agreement, which must be negotiated with executive officials designated by the governor and formally approved by the general assembly. The management agreement defines the authority that an institution may exercise and can affect financial operations, capital outlay, procurement, information technology, and human resources.

Under the restructuring legislation, all institutions requesting Level One authority would require their governing boards to pass resolutions authorizing their university administrations to enter into these agreements with the governor’s office and agree to the state’s ask.
In very broad strokes, these resolutions include:

  • Provide access to higher education for all citizens.
  • Ensure that higher education remains affordable.
  • Offer a broad range of undergraduate and, where appropriate, graduate programs.
  • Ensure that the institution’s academic programs and course offerings maintain high academic standards.
  • Improve student retention such that students progress from initial enrollment to a timely graduation and the number of degrees conferred increases as enrollment increases.
  • Develop articulation agreements that have uniform application to all Virginia community colleges.
  • Contribute to efforts to stimulate the economic development of the commonwealth and the area in which the institution is located.
  • Increase the level of externally funded research conducted at the institution, and facilitate the transfer of technology from university research centers to private-sector companies.
  • Work cooperatively with elementary and secondary school administrators, teachers, and students in public schools and school divisions to improve student achievement, upgrade the knowledge and skills of teachers, and strengthen leadership skills of school administrators.
  • Prepare a six-year financial plan.
  • Conduct the institution’s business affairs in a manner that maximizes operational efficiencies and economies.

At the other end of the spectrum, institutions that qualify for and seek Level Three status would be granted additional authorities in specific areas of impact. Among the additional authorities granted by the legislation:

University governance: Allows governing boards to assume full authority for the management of the institution.

Financial management: Provides a framework for the institution to develop its own financial management policies including setting, holding, and investing its tuition, fees, research funds, auxiliary enterprise funds, and all other public funds.

Investments: Allows governing boards to adopt written investment guidelines for investing operating funds.

Human resources: Allows governing boards to adopt a human resources system for its classified employees. The state’s retirement system, health insurance, workers’ compensation coverage program, and grievance procedures will continue to apply to classified staff and faculty members as these programs currently apply.

Capital projects: Continues decentralization authority for non-general fund projects and extends current pilot project on general fund projects subject to the adoption of board-approved policies for the review, approval, and implementation of all capital projects.

Acquisitions: Extends current authority to all real and personal property with non-general funds without prior approval in accordance with policies adopted by governing boards.

For all levels, upon making such commitments to the governor and the general assembly by August 1, 2005, the institution will be allowed to exercise the restructured financial and operational authority. This includes retaining interest earnings on tuition and fees, mandatory reappropriation of unexpended balances, a rebate on purchases made through the small charge card, and a rebate on sole source procurements made though eVa, the state’s electronic procurement system for which the institution has paid fees.

Each June, institutions will be evaluated by the State Council of Higher Education for Virginia to see whether they have met the state’s objectives based on performance indicators for financial and administrative management developed by the governor and SCHEV. If institutions meet the criteria, they will receive the financial benefits July 1 of the next fiscal year. If institutions comply with the provisions of the restructuring act, the state comptroller at the end of each fiscal year will designate within the annual report an amount for nonrecurring expenditures, which shall equal the remaining amount of the general fund balance that is not otherwise reserved or designated.

Colorado’s Taxpayer’s Bill of Rights (TABOR) is a constitutional amendment passed in 1992 that limits state revenue and prevents institutions from raising tuition above a certain level. This legislation has had a twofold effect on higher education funding in Colorado. First, it has limited the amount of additional state support available to address rising costs of operation. Second, it has reduced the ability of institutions to offset shortfalls in state support by increasing tuition.

As a result, to address funding needs at its public institutions, the Colorado State Legislature passed an act in May 2004 that would provide state tax dollar support for higher education at the undergraduate level. Under this act, the state would no longer appropriate monies directly to institutions for undergraduate education. Instead, the state would provide direct funding to undergraduate students through the College Opportunity Fund. The COF bill created a mechanism to exempt higher education tuition from the TABOR limit, thereby allowing greater financial flexibility for public institutions. Because funding is provided to students through the stipends and to the institutions through fee-for-service arrangements, the bill allows all qualifying public institutions to be designated as “enterprises” if approved by the legislative audit committee.

Starting in fall 2005, all undergraduate students would be sent a tuition bill. In-state students would apply for COF vouchers. These vouchers would then be applied toward the student’s university bill, thereby reducing the overall tuition level owed by an amount that would recognize state support. For example, if a student’s total tuition was $2,000 and he or she applied for the voucher and authorized its use, the COF would cover $800 and the student would be responsible for the remaining $1,200. However, if the student did not apply for the voucher and authorize its use, he or she would be responsible for paying the full $2,000.

Ohio: Resident Scholarships

A variation of the Colorado voucher model has been implemented by Ohio’s Miami University. Under the Ohio Scholarship Program created by the university, Miami has adopted the practice of independent universities in having a single tuition for all applicants. Annual tuition for Miami University in FY05-06 is $21,410. To offset the increase for Ohio residents, Miami offers scholarships reserved exclusively for Ohio students, whether continuing or new enrollments.

All accepted Ohio residents attending Miami University receive two scholarships from the university: the Ohio Resident Scholarship and the Ohio Leader Scholarship. The amount of the Ohio Resident Scholarship—$4,850—is equal to or greater than the per-student appropriation that Miami receives from the state. The amount of the university’s Ohio Leader Scholarship varies because it is tied to financial need. For freshmen entering in FY05-06, the minimum is set at $6,052 and could be as much as $7,850.
The stated goal of Miami University’s Ohio Scholarship Program is to make Miami more affordable to moderate-income families in Ohio by giving the university more pricing flexibility and by emphasizing the availability of scholarships for state residents. Through this approach, Miami is recognizing that the state is one of several sources of funding but is not the sole or primary source of support.

Developing New Funding Relationships

As the models depicted in this article suggest, a growing number of public colleges and universities are evolving from primarily state-supported institutions to state-assisted or even state-related institutions. Amid the complexity of these scenarios, all these institutions can attest that developing alternative funding approaches raises critical questions that public colleges and universities must address. Various factors affect the types of funding relationships that institutions enter into with state governments.

Governance structures. How public institutions are organized and governed determines how they are able to respond to opportunities and challenges. For example, if an institution is part of a university system, the goals of an individual institution must be considered within the goals of the system as a whole. In an institution with its own governing board, decisions are focused on the impact of actions on the individual institution.

Governance structures also determine the point of interface between state governments and their public universities. For example, the funding compacts in California were between the governor and the UC and CSU systems. In Virginia, the restructuring act required agreements between the state and the governing boards of each public university in the commonwealth.

All public institutions are accountable to the citizens of their respective states. However, how institutions are constituted determines their ability to operate within the context of other state agencies. The University of California, for example, is constitutionally autonomous and can set its own tuition and fees. In other states, the ability to set fee levels is under the control of the state and is frequently specified in the language of the appropriation act. 

Funding approaches. In redefining funding partnerships, the manner in which public universities are funded by the state is a critical factor. In the case of California, both the UC and CSU systems are funded on an incremental or decremental basis—that is, the institutions have a base level of funding that in good economic times is augmented by increased state appropriations for special initiatives or in bad times is decremented through budget reductions to base funding levels.

Public universities in Virginia are funded on the basis of a modified funding formula called base enhancement. In this case, base levels of funding are augmented by additional state appropriations that try to bring the institutions to levels found at a comparable set of peer institutions. The metric used in determining funding is tied to bringing faculty salaries to the 60th percentile of a specific peer group. In good economic times, progress is made through a combination of increased state appropriations and tuition increases. In bad times, erosion of this base level can occur through cuts to base budget levels.

In the case of the compacts or partnerships, UC and CSU sought guarantees on the level of support the state could provide. Public universities in Virginia sought both administrative and financial flexibility to create predictable financial plans that would allow families to plan for a predictable level of tuition increases under two scenarios: the first given a specified level of state support under base enhancement funding, and an alternative scenario with tuition increases offsetting reduced levels of state support.

With Colorado and Miami University, the understanding that state support is no longer the primary source of funding is recognized by a move to a state voucher or scholarship program. In Colorado, the goal was to provide for adequate and predictable funding to flow to a public institution that had been subject to the limitations imposed by the state’s TABOR. The bill also allowed a state institution that enters into a performance contract with the state’s department of education to request an exemption from the procurement code and the central motor vehicle fleet system. However, the bill also specifies that while a state institution is operating pursuant to a performance contract, the general assembly retains the authority to approve tuition spending authority for the governing board of the institution. Thus, the state will grant flexibility in administrative operation while exercising control over the setting of a revenue stream—in this case, the setting of tuition levels.

At Miami University, the focus was not on guaranteeing a certain level of state support (such as the levels specified in California’s partnerships or compacts) but on making the university more affordable to moderate-income families in Ohio by giving it more pricing flexibility in the setting of tuition and the administration of state support. It is also the hope of the university that the tuition and scholarship restructuring initiative will allow Miami—considered a “public Ivy”—to compete more effectively against its independent university competitors for the best and brightest Ohio students.

Executive agreements or legislation. Funding compacts or partnerships in California have been agreements between standing governors and university systems. The restructuring initiative in Virginia involved agreements with the governor, but elements of these agreements are incorporated into legislation that requires the active participation and approval by both the executive and legislative branches.

The form of these agreements is determined in part by the structure of state government. For example, governors in Virginia can serve only one four-year term while governors in California can serve two consecutive four-year terms. California has term limits for legislators whereas Virginia does not.

The plus side of legislative agreements is that all parties are active participants versus having the legislative body react to agreements between the executive branch and higher education institutions or systems. The downside is that there has to be a commitment by all parties to reach closure, and this process may potentially take several years. The development of partnerships between UC and CSU and the administrative branch of government has taken place in a matter of months, while the process in Virginia has taken two years.

Incentives and accountability. In both Virginia and California, funding agreements have required public institutions to commit to certain performance or accountability measures. While some of these measures merely mirror the established goals and missions of an institution—such as access and public service—others require measurable outcomes. The issue then becomes the value of gaining some administrative or financial flexibility at the expense of greater administrative oversight or control. In the cases of California and Virginia, public institutions have found that the advantages of such relationships outweigh the disadvantages.

Colorado’s COF bill requires each governing board of a state institution (and any independent institution that intends to receive stipends on behalf of students) to negotiate a contract that specifies the performance goals the institution shall achieve during the period that it operates under the contract. Once again, financial and administrative flexibility is granted in exchange for increased accountability. This accountability is manifested not only through performance contracts, but also by monitoring tuition levels at public higher education institutions. For example, beginning with the state fiscal year commencing July 1, 2005, the tuition increases from which the general assembly derives the total cash spending authority for each governing board is to be noted in a footnote to the general appropriations bill. 

Formalizing Commitment

As more public institutions across the nation address the need to formalize funding commitments with their states, additional models will surface in response to specific concerns. For instance, funding agreements with state governing bodies in California and Virginia were initiated to improve communication on funding issues, gain administrative and financial flexibility, or create more predictable levels of state and non-state support. While this process is still under way in Virginia, the funding agreements in California have generated one recurring benefit: They have created a basis for an ongoing dialogue between the state and its higher education institutions surrounding the need to adequately support its public systems of higher education.

While funding may exceed expectations in good times and fall short in bad times, the structures of these agreements allow states to recalibrate and in some areas reinforce funding commitments. More importantly, they reinforce the need for—and facilitate the process of—ongoing communication between states and their public colleges and universities.

Author Bio  James A. Hyatt is executive vice president and chief operating officer for Virginia Polytechnic Institute and State University, Blacksburg, Virginia. He served as vice chancellor for budget and finance and chief financial officer for the University of California–Berkeley from 1991 to 2004. The author thanks Richard M. Norman, vice president of finance and business services at Miami University, Oxford, Ohio, for his assistance with this article.