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

Intersegmental: Higher Education Enrollment Growth and Funding

The Governor's budget proposes $88.7 million to fund 2.5 percent enrollment growth at the University of California (UC) and the California State University (CSU). This amount would provide $7,588 in General Fund support for each additional student at UC and $6,270 for each additional student at CSU. The proposed budget also provides $142 million for a 3 percent increase of enrollment at California Community Colleges. In this section, we (1) review current-year enrollment levels at UC and CSU, (2) analyze the Governor's proposed enrollment growth and funding rates for 2005-06, and (3) recommend alternatives to those funding rates.

Higher Education Enrollment Trends

In 2003, approximately 2.2 million students (headcount) were enrolled either full-time or part-time at the University of California (UC), the California State University (CSU), and California Community Colleges (CCC). This is equal to roughly 1.7 million full-time equivalent (FTE) students. (We describe the differences between headcount and FTE in the accompanying text box.) Figure 1 displays actual headcount enrollment for the state's public colleges and universities for the past 40 years. The figure shows that enrollment grew rapidly through 1975 and then fluctuated over the next two decades. Since 1995, enrollment grew steadily until a slight decline in 2003. As we discuss in the taking relatively few courses. Despite this drop in headcount, there was a much smaller decline in community college FTE enrollment from 2002 to 2003.

Enrollment Down in 2004-05, But Master Plan Intact

As a reference point to guide legislative and executive decisions, the Master Plan for Higher Education (adopted by the Legislature in 1960 and periodically reassessed) established admission guidelines that remain the state's official policy today. Each year, UC and CSU typically accommodate all eligible freshman applicants. In enacting the 2004-05 budget, the Legislature rejected the Governor's proposal not to admit some eligible freshmen, and instead required that UC and CSU accommodate all eligible students as called for in the Master Plan. (See accompanying box for further information about this proposal.)

The 2004-05 Budget Act nevertheless included reductions to budgeted enrollment levels at both UC and CSU.

• For UC, the budget established a total enrollment target of 200,976 FTE students. However, as indicated in Figure 2, this amount is about 900 students fewer than the number of students actually served in the prior year.
• For CSU, the budget established a total enrollment target of 324,120 FTE students. However, as indicated in Figure 3, this amount is about 7,600 FTE students fewer than the number of students actually served in the prior year.

Despite the above reductions to budgeted enrollment levels at UC and CSU, the state has been able to maintain the Master Plan's commitment to college access. Specifically, the segments indicate that no eligible applicants were denied admission to the universities as a whole in 2004-05. (We recognize, however, that some eligible applicants were not admitted to their preferred campus as happens every year.)

Disconnect Between Enrollment Funding and Actual Enrollment

The budgeted enrollment levels funded in each year's budget are targets for which funding is provided. Because the number of eligible students enrolling at the segments cannot be predicted with complete accuracy, in any given year UC and CSU typically serve slightly more or less FTE students than budgeted. Recently, however, actual enrollment has deviated more significantly from funded levels. As we discussed in our Analysis of the 2004-05 Budget Bill (page E-182), for example, CSU enrolled significantly fewer students than it was funded for in 2003-04. This was because the university redirected a significant amount of enrollment funding to essentially "backfill" budget reductions in other program areas. Although not in the same magnitude, UC also redirected some enrollment funding to other purposes in 2003-04.

In recognition of the above disconnect between the number of students funded at each segment and the number of students actually enrolled, the Legislature adopted provisional language as part of the 2004-05 Budget Act to ensure that UC and CSU use enrollment funding for enrollment. Specifically, the 2004-05 budget required that UC and CSU report to the Legislature by March 15, 2005, on whether they met their current-year enrollment targets (200,976 FTE students for UC and 324,120 FTE student for CSU). If the segments do not meet these goals, the Director of the Department of Finance (DOF) is to revert to the General Fund the total amount of enrollment funding associated with the share of the enrollment goal that was not met.

At the time of this writing, UC is projected to exceed its budgeted enrollment target by roughly 600 FTE students, for a total of 201,621 FTE students. The CSU was unable to provide an estimate of the actual number of students currently enrolled at the university. However, the university tells us it expects to meet its current-year enrollment target.

Governor's Budget Proposal

The budget requests a total of $225.4 million in General Fund support to increase enrollment at UC , CSU, and CCC. The $225.4 million total consists of:

• $37.9 million to UC for 2.5 percent enrollment growth (or 5,000 FTE students) above current-year budgeted enrollment, which is based on a marginal General Fund cost of $7,588 per additional student. (This amount includes funding for 1,000 new FTE students at the Merced campus, which will open in fall 2005.)
• $50.8 million to CSU for 2.5 percent enrollment growth (or 8,103 FTE students) above current-year budgeted enrollment, which is based on a marginal General Fund cost of $6,270 per additional student.
• $142 million (Proposition 98) to CCC for 3 percent enrollment growth (or 34,000 FTE students) above current-year budgeted enrollment, which is considerably higher than the statutory growth rate of 1.89 percent. (We further discuss enrollment at CCC in the "California Community Colleges" section of this chapter.)

Determining Enrollment Growth Funding for 2005-06

One of the principal factors influencing the state's higher education costs is the number of students enrolled at the three public higher education segments. Typically, the Legislature and Governor provide funding in the annual budget act to support a specific level of enrollment growth at the state's public higher education segments. The total amount of enrollment growth funding provided each year is based upon a per-student funding rate multiplied by the number of additional FTE students. For example, the Governor's budget proposes a per-student funding rate of $6,270 for 8,103 additional students at CSU, for a total of $50.8 million.

As earlier noted, the proposed budget includes a total of $88.7 million for 2.5 percent enrollment growth at UC and CSU. In reviewing the Governor's enrollment growth funding proposal, the Legislature must determine the following:

• How much enrollment growth (or additional students) to fund at UC and CSU for 2005-06?
• How much General Fund support to provide the segments for each additional student (commonly known as the "marginal cost")?

Below, we examine each of these issues and make recommendations concerning the Governor's enrollment funding proposals.

How Much Enrollment Growth Should Be Funded?

Determining the amount of additional enrollment to fund each year can be difficult. Unlike enrollment in compulsory programs such as elementary and secondary school, which corresponds almost exclusively with changes in the school-age population, enrollment in higher education responds to a variety of factors. Some of these factors, such as population growth, are beyond the control of the state. Others, such as higher education funding levels and fees, stem directly from state policy choices. Although the Master Plan sets eligibility targets, it is often difficult to accurately predict factors that affect the level of demand for higher education. As a result, most enrollment projections have had limited success as predictors of actual enrollment demand.

In general, there are two main factors influencing enrollment growth in higher education:

• Population Growth. Other things being equal, an increase in the state's college-age population causes a proportionate increase in those who are eligible to attend each segment. Population growth, therefore, is a major factor driving increases in college enrollment. Most enrollment projections begin with estimates of growth in the student "pool," which for the rest of this decade is expected to range from a little more than 1 percent to about 2.5 percent annually.
• Participation Rates. For any subgroup of the general population, the percentage of individuals who enroll in college is that subgroup's college participate rate. California's participation rates are among the highest in the nation. Specifically, California currently ranks fourth (tied with four other states) in college enrollment among 18- to 24-year-olds, and first among 25- to 49-year-olds. However, predicting future changes to participation rates is difficult because students' interest in attending college is influenced by a number factors (including student fee levels, availability of financial aid, and the availability and attractiveness of other postsecondary options).

Provide 2 Percent Enrollment Growth

Based on our demographic projections, we recommend the Legislature reduce the Governor's proposal for budgeted enrollment growth for the University of California and the California State University from 2.5 percent to 2 percent. Our proposal should easily allow the segments to accommodate enrollment growth next year due to increases in population, as well as modest increases in college participation.

If college participation rates remain constant for all categories of students next year, we project that enrollment at UC and CSU will grow roughly 1.5 percent from 2004-05 to 2005-06. (See accompanying text box for a description of the demographics-based methodology we developed to estimate future higher education enrollment levels.) Since this projection is driven solely by projected population growth, it should serve as a starting point for considering how much enrollment to fund in 2005-06. In other words, the Legislature can evaluate how various related budget and policy choices could change enrollment compared to this baseline. We note that over the years the Legislature has taken deliberate policy actions (such as funding student outreach programs and expanding the availability of financial aid) to increase college participation rates. Consistent with these actions, the state has provided funding for enrollment growth in some of those years that significantly exceeded changes in the college-age population.

In view of the Legislature's interest in increasing college participation, we recommend funding 2 percent enrollment growth at UC and CSU for the budget year. This is about one-third higher than our estimate of population-driven enrollment growth, and therefore should easily allow the segments to accommodate enrollment growth next year due to increases in population, as well as modest increases in college participation. More importantly, our recommended 2 percent growth rate helps preserve the Legislature's priority that UC and CSU accommodate all eligible students (as called for in the Master Plan).

Accordingly, we recommend that the Legislature reduce the Governor's proposed enrollment growth for UC and CSU from 2.5 percent to 2 percent. (In the next section on per-student funding rates, we discuss the General Fund savings associated with reducing the Governor's proposed growth rate.)

Ensuring That Enrollment Targets Are Met

We recommend the Legislature adopt budget bill language specifying enrollment targets for both the University of California and the California State University, in order to protect its priority to increase higher education enrollment.

Although the Governor's budget would increase funded enrollment by 2.5 percent at UC and CSU, the total number of students the segments in fact would serve in 2005-06 is not clear. This is because the proposed budget bill departs from recent practice and does not hold the segments accountable for meeting a specific budgeted enrollment target.

We believe that the Legislature, the Governor, and the public should have a clear understanding of how many students are funded at UC and CSU in the annual budget act. Additionally, the segments should be expected to use enrollment funding provided by the state for that purpose and be held accountable for meeting their annual enrollment targets as adopted by the Legislature. If UC or CSU does not meet its goal, the amount of enrollment funding associated with the enrollment shortfall should return to the state's General Fund. However, under the Governor's proposal, the segments would have the flexibility to reduce enrollments at their discretion regardless of the Legislature's priority to increase enrollment. As previously discussed, there has been a disconnect in recent years between funded and actual enrollment. This is because the segments have redirected enrollment funding away from serving additional students essentially to maintain services in other program areas.

For the above reasons, we recommend the Legislature establish specific enrollment targets (based on our recommended 2 percent enrollment growth) and accountability provisions for UC and CSU. We propose language for 2005-06 that is similar to what was adopted in 2004-05. First, we propose the Legislature add the following provision to Item 6440-001-0001:

The amount appropriated in Schedule (1) includes funding for the University of California to enroll 204,996 full-time equivalent (FTE) students. The Legislature expects the university to enroll this number of FTE students during the 2005-06 academic year. The university shall report to the Legislature by March 15, 2006, on whether it has met the 2005-06 enrollment goal. If the university does not meet this goal, the Director of the Department of Finance shall revert to the General Fund the total amount of enrollment funding associated with the share of the enrollment goal that was not met.

Similarly, we also recommend adding the following provision to Item 6610-001-0001:

The amount appropriated in Schedule (1) includes funding for the California State University to enroll 330,602 full-time equivalent (FTE) students. The Legislature expects the university to enroll this number of FTE students during the 2005-06 academic year. The university shall report to the Legislature by March 15, 2006, on whether it has met the 2005-06 enrollment goal. If the university does not meet this goal, the Director of the Department of Finance shall revert to the General Fund the total amount of enrollment funding associated with the share of the enrollment goal that was not met.

How Much General Fund Support Should Be Provided for Each Additional Student?

In addition to deciding the number of additional FTE students to fund in 2005-06, the Legislature must also determine the amount of funding to provide for each additional FTE student at UC and CSU. Given recent practice, this funding level would be based on the marginal cost imposed by each additional student for additional faculty, teaching assistants (TAs), equipment, and various support services. The marginal cost is less than the average cost because it reflects what are called "economies of scale"—that is, certain fixed costs (such as for central administration) which may change very little as new students are added to an existing campus. The marginal costs of a UC and CSU education are funded from the state General Fund and student fee revenue. (A similar, but distinct, approach is used for funding enrollment growth at community colleges.)

The current practice has been for the state to provide a separate funding rate for each higher education segment. In other words, the state uses a model of differential funding—providing separate funding rates for distinct categories of students—based on which higher education segment the student attends. (As we discuss below, the state in the past has provided separate funding rates based on education level and type of instruction.) As discussed above, the Governor's budget for 2005-06 proposes to provide $7,588 in General Fund support for each additional student at UC and $6,270 for each additional student at CSU.

Background on the Development of the Marginal Cost Methodology

For many years, the state has funded enrollment growth at UC and CSU based on the marginal cost of instruction. However, the formula used to calculate the marginal cost has evolved over the years. In general, the state has sought to simplify the way it funds enrollment growth. As we discuss below, the state has moved from utilizing a large number of complex funding formulas for each segment to a more simplified approach for calculating enrollment funding that is more consistent across the two university systems.

UC and CSU Used Different Methodologies Before 1992

From 1960 through 1992, CSU's enrollment growth funding was determined by using a separate marginal cost rate for each type of enrollment category (for example, lower division lecture courses). In other words, the different marginal cost formulas took into account education levels—lower division, upper division, and graduate school—and "instructional modes" (including lecture, seminar, laboratories, and independent study). Each year, CSU determined the number of additional academic-related positions needed in the budget year (based on specific student-faculty ratios) to meet its enrollment target. These data were used to derive the separate marginal cost rates. Unlike the current methodology, the marginal cost formulas before 1992 did not account for costs related to student services and institutional support. The state made funding adjustments to these budget areas independent of enrollment funding decisions.

Similar to CSU, annual enrollment growth funding provided to UC before 1992 was based on the particular mix of new students, with different groups of students funded at different rates. However, UC's methodology for determining the marginal cost of each student was much less complex than CSU's methodology and did not require different rates based on modes of instruction. The university only calculated separate funding rates for undergraduate students, graduate students, and for each program in the health sciences based on an associated student-faculty ratio. For example, the marginal cost of hiring faculty for new undergraduate students was estimated by dividing the average faculty salary and benefits by 17.48 FTE students (the undergraduate student-faculty ratio at the time). Each marginal cost formula also estimated the increased costs of library support due to enrolling additional students. As was the practice for CSU, however, UC's marginal cost formulas did

Legislature Called for New Methodology in 1990s

Beginning in 1992-93, the Legislature and Governor suspended the above marginal cost funding practices for UC and CSU. While the state did provide base budget increases to the universities, it did not provide funding specifically for enrollment growth during that time. In the Supplemental Report of the 1994 Budget Act, the Legislature stated its intent that, beginning in the 1996-97 budget, the state would return to the use of marginal cost as the basis for funding enrollment. Specifically, the language required representatives from UC, CSU, DOF, and our office to review the 1991-92 marginal cost formulas and propose improvements that could be used in developing the 1996-97 budget. The working group had two primary goals: (1) updating the calculations to more accurately reflect actual costs and (2) establishing more consistency between segments in the methods used to fund enrollment growth. This work coincided with CSU's efforts to simplify the university's budget development process, streamline budget formulas, and increase the system's budget discretion.

After a series of negotiations in 1995, the four agencies developed a new methodology for estimating the amount of funding needed to support each additional FTE student. The new methodology was first implemented in 1996-97 and has generally been used to calculate enrollment funding ever since. Some of the key features of this methodology include:

• Single Marginal Cost Formula for Each Segment. Enrollment growth funding is no longer based on differential funding formulas by education level and academic program. Instead, each university segment uses one formula to calculate a single marginal cost that reflects the costs of all the system's education levels and academic programs. For instance, a fixed student-faculty ratio (as adopted in the budget act) helps determine the faculty costs associated with each additional student (regardless of education level). Thus, the state currently provides a different per-student funding rate depending only on which higher education segment that student attends. (See nearby text box for a review of the different types of differential funding and their potential benefits and drawbacks.)
• Marginal Cost for Additional Program Areas. The working group concluded that the marginal cost formula should include additional cost components beyond salaries for faculty, teaching assistants, and other academic support personnel. As a result, the current formula takes into account the marginal costs for eight program areas—faculty salary, faculty benefits, TAs, academic support, instructional support, student services, institutional support, and instructional equipment. These program costs are based on current-year funding and enrollment levels, and then discounted to adjust for fixed costs that typically are not affected by year-to-year changes in enrollment.
• Student Fee Revenue Adjustments. In addition, the working group suggested that both the General Fund and student fee revenue should contribute toward the total marginal cost. This is because fee revenue is unrestricted, and is thus used for general purposes the same as General Fund revenue. It also reflects the state's policy that students and the state should share in the cost of education. Therefore, under the methodology, a portion of the student fee revenue that UC and CSU anticipate from the additional students is subtracted from the total marginal cost in order to determine how much General Fund support is needed from the state for each additional FTE student.

Recent Departure From the 1995 Marginal Cost Methodology

After the above marginal cost methodology was developed in 1995, UC and CSU used it every fall to estimate the amount of funding they would require for each additional FTE student enrolled in the coming year. (If necessary, the estimate is later updated to reflect revised current-year expenditures.) From 1996-97 through 2003-04, these amounts were in turn used in the annual budget act to fund enrollment growth at UC and CSU. However, the budgets adopted for the current year (2004-05) and proposed for the budget year (2005-06) depart from this practice and rely on a slightly different methodology used by DOF.

Different Methodology Used for CSU in 2004-05 Budget. The 2004-05 Budget Act included new enrollment funding for CSU based on DOF's calculation of a marginal General Fund cost of $5,662 per additional FTE student. According to CSU, however, the 1995 methodology would have called for $5,773 in General Fund support per student. (This is the rate approved by the CSU Board of Trustees as part of its budget request to the Governor.) The DOF's calculation departs from the 1995 methodology in that it is based on funding and enrollment levels proposed for 2004-05, rather than as budgeted in 2003-04.

Unexplainable Methodology Proposed for UC in Governor's 2005-06 Budget. For 2005-06, the Governor proposes to provide $7,588 in General Fund support for each additional student at UC. However, it is unclear how the administration calculated this per-student funding rate. At the time of this analysis, DOF staff could neither substantiate nor explain the methodology it used to derive the $7,588 proposed marginal cost. In a departure from past practices, DOF staff declined to provide the specific formulas and data supporting its proposal. Thus, we are unable to conclude whether the administration is proposing an entirely new methodology for UC in the budget year. As we discuss below, UC calculated a different marginal cost rate as part of its 2005-06 budget request.

LAO Recommendations Based on 1995 Methodology

Using our marginal cost estimates for enrollment growth based on the agreed-upon 1995 methodology and our proposed 2 percent enrollment growth, we recommend deleting $21.3 million from the combined $88.7 million requested in the budget for enrollment growth. Our proposal would leave sufficient funding to provide $7,180 for each additional University of California student and $5,999 for each additional California State University student. (Reduce Item 6440-001-0001 by $9.4 million and Item 6610-001-0001 by $11.9 million.)

Until the Legislature approves a new marginal cost methodology, we believe that it should fund enrollment growth at UC and CSU in the 2005-06 budget that is aligned with the 1995 methodology. Using our marginal cost estimates for enrollment growth based on the agreed-upon 1995 methodology, we recommend alternatives to the Governor's proposed funding rates.

Provide $7,108 in General Fund Support for Each Additional UC Student. As discussed above, it is unclear how the administration calculated its proposed marginal General Fund cost of $7,588 for each additional student at UC. More importantly, as we discuss below, this rate is considerably different from our estimate of what would be called for under the marginal cost methodology developed in 1995. As part of its 2005-06 budget request to the Governor this past fall, the UC Board of Regents approved a marginal General Fund cost of $7,528 per FTE student that is based on the 1995 marginal cost methodology (see Figure 4).

However, since UC calculated this rate several months ago, it does not reflect current legislative policies and expenditure data. For example, as part of the 2004-05 budget package, the Legislature approved the Governor's proposal to increase the student-faculty ratio at UC from 19.7:1 to 20.7:1 in order to achieve ongoing General Fund savings. As noted in Figure 4, however, the faculty salary and benefits included in the university's own marginal cost calculation is based on a student-faculty ratio of 18.7:1. In addition, the average cost per FTE student for instructional support, academic support, and institutional support reflect initial planning estimates for the current year. (The Governor's budget for 2005-06 displays revised funding data for 2004-05.) After making the above adjustments, we calculate a marginal General Fund cost at UC of $7,108 based on the 1995 methodology.

Provide $5,999 in General Fund Support for Each Additional CSU Student. Figure 5 displays a simplified version of the marginal cost calculations used by CSU to estimate the $6,270 per FTE student funding rate proposed in the Governor's budget for 2005-06. As noted in the figure, the identified costs associated with faculty salary and benefits assume a student-faculty ratio of 18.9:1. However, as was done for UC, the Legislature in the last two budget acts increased the student-faculty ratio at CSU as a cost-cutting measure. Specifically, the 2004-05 Budget Act assumed $53.5 million in General Fund savings from increasing the student-faculty ratio by 5 percent (from 19.9:1 to 20.9:1). In effect, this higher ratio means that fewer new faculty positions are necessary to teach a cohort of additional students than otherwise would be needed with a lower ratio. Thus, an increase in the student-faculty ratio effectively reduces the marginal cost per additional FTE student. We estimate that a student-faculty ratio of 20.9:1 results in a marginal General Fund cost of $5,999 for CSU.

In view of the above technical adjustments, we recommend the Legislature provide $7,180 in General Fund support for each additional student at UC and $5,999 for each additional student at CSU. (See Figure 6 for a detailed description of our marginal cost calculations.) Given our earlier proposal to fund enrollment growth at a rate of 2 percent at both UC and CSU, we therefore recommend reducing the proposed General Fund augmentation for enrollment growth by a total of $21.3 million, including $9.4 million from UC and $11.9 million from CSU. Under our proposal, the segments would still receive sufficient funding to cover the estimated costs of enrollment growth due to increases in population and college participation.

Legislative Review of Marginal Cost Methodology Needed

We believe the Legislature should revisit and reassess the marginal cost methodology. Specifically, we recommend the Legislature direct our office, in consultation with representatives from the Department of Finance, the University of California, and the California State University, to review the current system of funding new enrollment and propose modifications for use in the development of future budgets.

The Legislature's most recent review of the Master Plan (in 2002) called for an assessment of the existing marginal cost formula. According to the 2002 Joint Committee to Develop a Master Plan for Education, "The State should analyze the appropriateness of modifying the current marginal cost approach for funding all additional enrollments in public colleges and universities, to account for contemporary costs of operations, differing missions and functions, and differential student characteristics that affect costs in each sector." Such a review is particularly important at this time because the Governor in his budget proposal is already deviating from the 1995 marginal cost methodology for UC. We also note that the segments themselves have expressed concern in the past about the adequacy of the existing marginal cost methodology.

Obviously, there are many ways to calculate the marginal General Fund cost for each additional student at UC and CSU. Based on our assessment of the current marginal cost methodology (as developed in 1995), we have developed a series of principles to guide the Legislature in determining how to more effectively fund the increased costs associated with enrollment growth. Figure 7 outlines the principles, which we discuss in further detail below.

Comparable Formulas for UC and CSU. We recognize that there are instances where it is reasonable to have different formulas for the segments, particularly in recognition of their differing missions and costs. However, under the current methodology, there is an unexplainable difference between the segments regarding the formulas used to adjust for fixed costs in two program areas (academic support and institutional support). For example, CSU's methodology includes a higher percentage of institutional support costs. (Institutional support primarily includes funding for the central administration offices of university presidents and chancellors.) Based on our conversations with the segments, we find no analytic reason why cost increases for institutional support would be different at the two segments.

Include Only Program Costs Linked to Enrollment Growth. The marginal cost formula should include only program costs that tie directly to enrollment growth. For example, the marginal cost should include funding to purchase instructional equipment for the additional students, but not to replace or upgrade existing equipment for use by existing students. Legislative decisions regarding funding for such nonenrollment-growth-related costs should be made independent of marginal cost funding. Moreover, there also may be some costs not included in the current marginal cost formula which increase when a university enrolls an additional student. Such costs (for instance, related to operation and maintenance services) might appropriately be added to the marginal cost methodology.

Input Data Should Reflect Actual Costs. The expenditure and enrollment data used to calculate the marginal cost at UC and CSU should appropriately reflect actual costs. For example, the costs for additional faculty and TAs should be determined based on current data regarding the salaries and benefits of existing personnel. We note that a key component of the current marginal cost methodology is an underlying assumption that the annual salary of a TA at CSU is roughly 50 percent of an entering faculty member's annual salary. For 2005-06, this translates to an estimated annual TA salary of about $38,000. According to the CSU Chancellor's Office, however, the average annual salary for a TA is currently only $7,180 (about 12 percent of an entering faculty member's salary). This means that the state is currently overbudgeting the marginal cost of hiring additional TAs. Conversely, there may be certain program costs that are not fully funded under the existing marginal cost formula.

Accurately Account for Available Student Fee Revenue. In order to determine how much General Fund support is needed from the state for each additional FTE student at UC and CSU, the marginal cost formula must "back out" the fee revenue that the segments anticipate collecting from each student. Under the current methodology, this is based on the percentage of the university's entire operating budget that is supported by student fee revenue. For example, if fee revenue makes up 40 percent of UC's budget for 2004-05, then fee revenue would be deemed to support 40 percent of the total marginal cost for 2005-06. The remaining 60 percent would be funded by the state's General Fund. A different approach could simply be to adjust the marginal cost based on the fee revenue collected for each FTE student (regardless of education level).

Moreover, the total amount of fee revenue collected by the segments is not always accounted for in the current methodology. For example, UC does not include the revenue collected from nonresident tuition when adjusting for fee revenues. Since the different program costs are based on expenditures from all fund sources (including nonresident tuition), then the marginal cost formula should include the supplemental fee paid by nonresident students in order to accurately determine the state's share of the total marginal cost. (An alternative approach would be to exclude nonresident tuition altogether from the marginal cost calculations.)

In conclusion, we recommend the Legislature direct our office, in consultation with DOF, UC, and CSU to review the current process of determining the amount of funding to provide for each additional FTE student and propose any modifications for use in the development of future budgets.