Analysis of the 2005-06 Budget Bill Legislative Analyst's Office February 2005

Intersegmental: Higher Education "Compact"

The Governor's 2005-06 budget proposal generally follows a "compact" between the Governor and the University of California (UC) and the California State University (CSU), agreed to in spring 2004. In return for specific funding commitments over the next six years, UC and CSU have agreed to meet various performance expectations negotiated with the Governor. Below, we explain our concerns with the Governor's compact and advise the Legislature to disregard it for budgeting purposes. Instead, we recommend the Legislature continue to use the annual budget process as a mechanism to fund its priorities and to hold the segments accountable for fulfilling the mission assigned to them by the Master Plan for Higher Education.

Background

In 1960, the state adopted a fiscal and programmatic roadmap for higher education in the form of the Master Plan for Higher Education. This document defines California's higher education goals and outlines strategies for achieving them. The guiding principle expressed in the Master Plan is that all qualified Californians should have the opportunity to enroll in high quality, affordable institutions of higher education. To achieve this goal, the Master Plan addresses various overarching matters, including governance structures and mission differentiation. It also establishes guidelines for eligibility pools, transfer policies, enrollment planning, facility utilization, financial aid, and other policy areas. The Master Plan has proven to be a remarkably enduring planning document, enjoying bipartisan support since its adoption. Starting in the mid-1990s, the state's public universities have entered into a series of nonbinding funding compacts to try to gain greater fiscal and programmatic stability.

Previous Higher Education Funding Agreements. In 1995, UC and CSU entered a four-year compact with the Wilson Administration following several years of fiscal uncertainty caused in large part by the state's economic recession. Under the agreement, the Governor committed to request at least a specified level of General Fund revenue in his annual budget proposals to support base budget increases, enrollment growth, and other priorities. In return, UC and CSU agreed to meet certain program objectives. Desiring to extend this arrangement, UC and CSU negotiated a new agreement with the Davis Administration in 1999. This agreement, known as the "Partnership," contained many of the same provisions of the previous compact. The Partnership agreement lasted from 1999 through 2003.

Previous Agreements Did Not Deliver Expected Funding. The Partnership agreement included provisions for a 5 percent annual base increase for UC and CSU. However, the state experienced a pronounced fiscal deterioration, caused by significantly lower-than-expected revenues. As a result, the Governor proposed in the May Revision to his 2001-02 budget to provide UC and CSU with a 2 percent base increase instead of the 5 percent called for under the Partnership. The following year he proposed a 1.5 percent base increase—again, less than outlined in the agreement. As shown by these and other experiences, the provisions of the segments' funding agreements are primarily expressions of intent at a point in time. They have not and cannot guarantee budgetary predictability to the public universities.

Development of the Current Agreement. In developing his budget proposal for 2004-05, the Schwarzenegger Administration confronted an estimated $17 billion General Fund shortfall. The Governor proposed to make up for some of this with General Fund reductions for UC and CSU, much of which was "backfilled" with revenue from student fee increases. While this budget proposal was being deliberated in the Legislature, the Governor developed a new compact with UC and CSU to provide annual budget increases beginning in 2005-06. The 2004-05 budget adopted by the Legislature approved some of the Governor's proposals for reductions at UC and CSU and significantly modified a few of them. The enacted budget made no reference to the compact.

Major Terms of the Current Agreement. The current compact would guide the Governor's budget proposals for the public universities through 2010-11. As Figure 1 shows, the compact establishes annual funding targets, including base increases of 3 percent (increasing to 4 percent in 2007-08 and 5 percent in 2008-09), 2.5 percent annual increases in enrollment funding, and annual fee increases that would generate additional funding to be used at the segments' discretion. As part of the compact, the segments agree to meet various programmatic expectations and to provide annual reports with specified information. (These are outlined in Figure 2 and discussed in further detail later in this section.)

Concerns With the Compact

The Governor's budget proposal for higher education largely is guided by his compact. Below, we identify several concerns with it.

Compact's Funding Targets Are Disconnected From Master Plan

The compact's funding expectations for enrollment growth, base increases, and student fees have no direct link to funding needs derived from the Master Plan.

No Link Between Master Plan and Compact's Enrollment Targets. The Master Plan provides guidance on eligibility criteria for each of the higher education segments. Specifically, UC is directed to accept students from the top one-eighth (12.5 percent) of high school graduates, CSU from the top one-third (33.3 percent) of high school graduates, and community colleges are to accept all applicants 18 years of age and older who can benefit from attendance. A recent report by the California Postsecondary Education Commission (CPEC) showed that in 2003, UC and CSU's eligibility criteria were not aligned with the eligibility targets outlined in the Master Plan. According to CPEC's analysis, UC drew its students from the top 14.4 percent of high school graduates (exceeding its 12.5 percent target by about one-seventh) and CSU drew its students from the top 28.8 percent of high school graduates (falling short of its 33.3 percent target by a similar proportion).

The annual increases in enrollment called for in the compact show no obvious link to the Master Plan's eligibility targets. They appear neither to address the mismatch between the Master Plan eligibility targets and current practice nor to mesh with projected growth in the college-age population over the next few years. Instead, the compact would provide UC and CSU identical fixed levels of annual enrollment growth for the term of the agreement. In contrast, we believe the Legislature should make enrollment funding decisions annually to provide the segments with the resources necessary to meet their Master Plan eligibility targets.

No Link Between Master Plan and Compact's Base Increases. The state's public universities, like other institutions, experience increases in their program costs due to inflation. In order to maintain the Master Plan's commitment to support quality academic programs, therefore, the Legislature periodically increases the segments' base budgets. To maintain the same purchasing power, these base increases would generally track an inflationary index such as the state and local deflator. The Governor's agreement with the segments, however, prescribes specific base increases through 2010-11, irrespective of the rates of inflation the segments will actually experience. Under the Governor's agreement with UC and CSU, the proposed base increases might match, exceed, or fall behind the annual rate of inflation.

We believe the Legislature should consider increasing the public universities' base budgets to adjust for the effects of inflation during annual budget hearings. Such consideration should weigh providing these increases against competing budget priorities. In this way, the Legislature maintains flexibility in the allocation of budget resources.

Compact's Fee Targets Are Arbitrary. The State Constitution confers on the Board of Regents the power to set student fee levels for UC, and the Legislature statutorily confers on the Board of Trustees the power to set fee levels for CSU. Both universities in recent years have determined fee levels as a response to the state's fiscal situation. For example, in the late 1990s, the public universities reduced fees—despite a strong economy and burgeoning financial aid opportunities—because state General Fund revenue was available to substitute for some fee revenue. Over the last couple of years, UC and CSU have raised student fees significantly to compensate for General Fund reductions. The Governor's agreement with the segments prescribes annual fee increases through 2010-11. Specifically, the compact proposes 8 percent fee increases in undergraduate fees in 2005-06 and 2006-07, with subsequent increases based on the change in per capita personal income. Graduate fees would increase by at least 10 percent in 2005-06 and 2006-07, with the segments committing to "make progress" in subsequent years toward the goal of raising graduate fees to 150 percent of undergraduate fees. This policy would ensure that fee increases are relatively moderate and predictable, but it does not provide an underlying policy rationale for the actual fee levels.

We believe the Legislature should instead adopt a long-term fee policy that results in students paying a fixed percentage of their total education costs each year. The size of the students' share would be a policy choice for the Legislature to make. This policy would provide an underlying rationale for fee levels, ensure moderate and gradual fee increases, and reflect underlying costs.

Compact Would Place Higher Education Funding on "Autopilot"

Compact Seeks Routine Increases. Rather than allowing for an annual review to reassess budget assumptions, the Governor's compact seeks automatic spending increases for UC and CSU. By prescribing specific targets for enrollment growth and base budget increases, the compact attempts to lock into place specific funding levels, thereby putting higher education on autopilot. As shown in Figure 3, by the final year of the compact, UC and CSU's General Fund support is projected to increase by about $2 billion from the 2004-05 level. When combined with student fee revenue, total resources for UC and CSU would increase by more than more $3.2 billion. In contrast, our projections of population growth and inflation suggest that UC and CSU would require an additional $1.8 billion in 2010-11, or about 60 percent of the increase called for by the compact. (Note: These figures do not include other increases that would be provided under the compact—such as funding for annuitant health benefits and capital outlay-related expenses.)

Budget Process Should Be Followed. The Legislature makes budget decisions within a context of changing fiscal, economic, and policy conditions. Unanticipated challenges, including natural disasters and economic downturns, require annual reassessments of funding needs as part of the budget process. To better accommodate these unexpected situations, as well as any policy changes the Legislature may want to implement, we believe the Legislature should reject the compact's autopilot approach and continue to use the annual budgetary process to allocate resources to the segments.

Compact's Accountability Provisions Are Inadequate

While we agree that accountability is an important issue directly connected with budgeting, we believe the accountability provisions referenced in the Governor's compact are inadequate for several reasons.

Compact's Accountability Lacks Explicit Goals and Measures. The Governor's agreement with the public universities includes performance measures as a means to monitor UC and CSU's progress toward meeting certain goals. Program goals and performance measures are important components of any successful accountability system. However, to be effective, goals should describe the desired outcomes or impact. Similarly, measures should directly relate to a specific goal, be quantifiable, and focus on results.

Although the compact makes an effort to measure various activities and outputs, it does not provide enough detail in the goals it hopes to achieve or in the measures it suggests to determine performance. For example, the compact lists a goal of "utilization of systemwide resources." Proposed measures of this goal include "faculty honors and awards," "information on technology transfer," and "instructional activities per faculty member." Using the criteria mentioned above, the proposed goal of utilization of systemwide services does not provide enough clarity about expected results. The lack of clarity, in turn, precludes the development of measures that accurately gauge progress toward the goal.

Compact's Accountability Not Focused on Outcomes. The Governor's agreement with the public universities includes output measures, which are concerned with the number of goods produced, rather than outcome measures, which focus on program results and impact on society. For example, the segments are expected to report the number of degrees awarded and instructional activities per faculty member. Although outputs are important, ultimately it is outcomes that provide insight into how well a program meets its mission.

Conclusion

The Master Plan for Higher Education serves as the state's framework for higher education. Since 1960, the Legislature, Governor, and public education segments have looked to the Master Plan for guidance on the operation and support of the state's public institutions of higher education. The Governor's budget proposal is based on an agreement he made with UC and CSU. The funding targets of this compact have no explicit link to the objectives outlined in the Master Plan. We recommend the Legislature continue to use the annual budget process as a mechanism to fund its priorities and to hold the segments accountable for fulfilling the mission assigned to them by the Master Plan for Higher Education.