Policy Analysis | November 2012

Higher Education Finance Reform

Jonathan Watts Hull

The Context

States are confronting a gap in the skills workforce needed to remain competitive in the emerging economy. Even as states slowly emerge from the devastation of the Great Recession, research has indicated that those workers with the least skills and education were the most affected and are having the hardest time bouncing back. Indeed, the Federal Reserve Bank of Cleveland raised concerns two years ago that low educational attainment actually was slowing the recovery. It has long been recognized that educational attainment correlates with income and employment. To close the skills gap and improve their economic prospects, states must find a way to increase the proportion of their population with postsecondary certificates and degrees.

States' interest in increasing college completion rates faces a very major hurdle, however: increasing costs. Participation spiked in recent years, particularly at two-year colleges, as more students sought security in college or to make themselves more competitive in the worst job market the United States has seen in generations. But this wave of students has somewhat passed, as they return to work or reach a limit on their willingness to borrow to pay for their degrees. Over this period, costs associated with college, which had been skyrocketing, leveled out slightly as the Great Recession took hold. According to the College Board, which has tracked this data for years, prices are on the rise yet again, signaling increasing difficulty for states to increase college completion rates. Higher college costs presents a dual problem of diminishing access and depressing completion, two drivers that are in direct opposition to state interests.

Institutions often point out that they increase tuition to offset declining state support and in response to an increasingly expensive operating environment, where high-skilled staff and advanced technology are essential parts of the enterprise, raising costs above those of other businesses. States reduced their support for higher education by 7.6 percent between 2011 and 2012 (although this reduction shrinks considerably when California's whopping 13 percent decline is factored out). Within the South, Texas and West Virginia have bucked this trend, increasing their support for higher education by 3.1 percent and 1.7 percent, respectively, two of only six states in the country to increase their spending on higher education in 2012. These increases are contrasted by some significant cuts in Louisiana (18.5 percent), Tennessee (15 percent), Oklahoma (14.5 percent) and Virginia (14.7 percent).

Cuts to higher education occur in the context of significant and ongoing pressures on state budgets from a host of areas, as well as a sluggish revival of tax revenues. The budgetary reality is that most states will find themselves in a poor position to increase their investments in higher education for several years to come. Because of this, states are considering a range of options to maximize their investments in postsecondary education, seeking policy levers to increase degree and certificate conferring, participation and completion, and research and development.

Paying for Performance

A number of states have attempted to promote increased numbers of graduates and participation through the use of performance incentives for institutions of higher education, additional funds available to schools for achieving specific benchmarks. A report from the National Research Council (funded by the Lumina Foundation) advocated productivity and quality measures for higher education based in part on completed degrees. Performance-based funding is not especially new, the concept of rewarding institutions for achieving state policy objectives dates back several decades. In general, performance programs have measured overall outcomes (generally graduation rates and degrees and certificates conferred), and added rewards for specific subgroups of students or degrees (low-income students or those graduating in high-need fields). Some programs may include student progression measures such as credit hours earned or student transfers.

The great majority of performance based funding systems constitute incentive programs, providing additional funds to schools for meeting specific criteria. With this approach, performance funds serve as a supplement to conventional fund ing, which is still based in some manner upon enrollment. Moreover, these incentives are dependent on funds being made available, something that is not always certain given the fiscal squeeze states have been facing in the past several years. For those states that have maintained their performance incentive programs, the scale of these incentives often is so small as to have very little impact on policy and practice at a campus level, especially as overall state support drops and is replaced with tuition and fees.

In some instances, institutional funding is linked to these outcomes or meeting specific targets. This model may include tuition deregulation as a component, a step Virginia took in 2005, and Florida will consider next year. With this approach, while performance takes a central role in the funding of the institution, schools must elect to participate. Not all schools are positioned to participate, and those that do often enjoy a degree of tuition autonomy, resulting in limited access. Louisiana has used a similar agreement system (the Granting Resources and Autonomy for Diplomas, or GRAD Act) since 2011, with schools authorized to increase their tuition by 10 percent annually (until they reach the regional average) so long as they maintain progress toward their goals.

Tennessee Makes a Change

Tennessee was in much the same situation as many states across the region: lower than desired post-secondary participation and completion rates, chronic limitations on finances, and a limited ability for the General Assembly to affect policy change at the system or institutional level. After years of discussion with stakeholders across the system, the General Assembly passed the Complete College Tennessee Act in 2010, which completely rewrote the state's higher education finance system. This funding formula, subject of a recent webinar from the SLC (materials, archived presentation and background available here), is unique among higher education finance systems in relying exclusively on performance to allocate funds.

Prior to the passage of the Act, the state funded colleges in much the same manner as other states, through the use of student enrollment counts with small incentives provided "on top" for meeting specific performance targets. The funding formula that developed from the Act eliminates every attendance measure, replacing it with funding based upon outcome measures. Each publicly funded institution in the state is awarded funding based on achieving specific educational outcomes, such as degrees or certificates conferred, credit hours earned at specific thresholds (indicating progress toward graduation), graduation rates, research and other measures. In order to respect the variety of institutional mission among schools in the state, these measures are weighted differently for each college or university depending on the kind of school. Additionally, because the state has an interest in increasing the college participation rates for minority, low-income and non-traditional students, the state amplifies the outcomes for students in these categories through the use of a multiplier in order to create meaningful incentives for institutions to reach out to these populations.

The advantage of the approach taken under the Act is that it provides the state with tremendous leverage to advance statewide policy interests through a single mechanism. Furthermore, the state is able to establish these priorities across the system and for individual institutions absent any additional funding, since the model allocates whatever state funds are made available. Because the model is entirely transparent, colleges and universities are able to align their programs to the mission outlined for them within the funding formula (which is mission-oriented in the first place) and increase the resources available to them (relative to previous years) by increasing outcomes that are most significantly weighted for that school.

Since Tennessee's adoption, this model has generated considerable interest among states, particularly in the South. Most recently Georgia announced that it would pursue a similar model. A panel convened by the Missouri General Assembly has also indicated it will fund at least part of its higher education formula based upon institutional performance. Similar activity is underway in Arkansas, Oklahoma and West Virginia.

Making the Transition

Shifting from enrollment-based funding poses complications for states. As state support for higher education has declined, the share of institutional revenue from tuition has increased. The effect of this is to diminish the impact supplemental funding and partial allocations of state appropriations can have on institutional behavior. If the state has articulated interests in increasing the number of individuals with certificates and degrees, but it only provides modest rewards to institutions that complete those goals, it is unlikely to witness large or systemic change. Some adjustments may occur, to be certain, but the scope and scale are proportionate to the amount of funds tied to the expected outcomes.

If, on the other hand, states tie significant amounts (or all) funding to performance outcomes, the alignment of state interests and institutional efforts will likely follow. States have experimented with transition periods of varying length and with varying degrees of allocations tied to outcomes. The essential interest is to avoid "shocking" an institution with a sudden drop in funding while still providing incentives for change. Averaging measures over several years can level out some of the transition while clearly signally the direction the institution is moving. For this reason, it is equally important that the measures, calculations, and objectives for the funding formula be public and transparent. Doing so ensures that the state and school both fully understand the impact the status quo has on funding as well as what areas the institution needs to focus on in order to increase their funding and maximize the investment of resources.

There is a risk with a performance based system that the outcomes can become easily manipulated and thus essentially meaningless. Moreover, it is important that the performance measures used reflect the mission of the institution. While it may be simplest to use a basic measure of graduation rates, such a metrics is not necessarily well-adapted to a wide range of institutions and student bodies and tends to reward selective schools for success that is not entirely related to their activities. Varying the importance of measures for institutions with different missions offers all schools an opportunity to succeed within the context of the purpose the school serves in the state. Recent work funded by the Gates foundation highlights the need to focus on student progression and completion, labor market signals, and assessments of student learning.

The second risk for states is that a measure of outcomes effects a diminishment of quality. This is a very key concern, regardless of the construction of the system. Protecting program quality is necessary to ensure that the increase in the number of certificate- and degree-holders in the state provides a meaningful expansion in the skills base for the state, and not simply an increase on paper with little value in the workforce. For institutions granting certificates and professional degrees with licensure or board examinations, monitoring program quality is relatively straightforward. For those programs in which such measures do not exist, however, caution may be required, tempered with outside review, to ensure that program productivity does not rise as a result in the loosening of standards.

Moving ahead

As states seek to maximize the return on their investment for higher education and continue to seek a more educated and skilled workforce, they likely will turn increasingly to outcome-based funding formulas as a mechanism to accomplish these goals. Success in this area requires several conditions, including clearly defined and well articulated goals for higher education, strong commitment across all levels and units of higher education to support outcomes-based funding, adequate data collection and integrity for system-wide and institutional decision making, a willingness among institutions to adjust practice to meet policy demands, and a support at the legislative and executive level to provide sufficient resources to higher education to accomplish state goals.