Analysis of the 2008-09 Budget Bill: Education

Intersegmental: LAO Alternative Budget Proposal

In the Perspectives and Issue, our companion publication to this Analysis, we outline an alternative to the Governor's 2008‑09 budget proposal. Our approach is distinguished from the Governor's in several notable respects. For example, while the Governor's budget relies largely on spending reductions to close a large projected budget shortfall, we have sought to incorporate a mix of expenditure reductions and increased revenues. We have also avoided the Governor's across–the–board approach to spending reductions in favor of more tailored reductions that take into account the consequences of potential reductions to various programs, weighing the relative costs and benefits of the different options.

The portion of our alternative budget related to higher education is described in this section. In general, we have sought to ensure that the state would be able to maintain its commitments of access and affordability as embodied in its Master Plan for Higher Education. More specifically, our alternative budget would accommodate anticipated budget–year enrollment growth, fund nondiscretionary cost increases, limit student fee increases to affordable levels, and expand funding for financial aid—both through the Cal Grant programs and campus–based institutional aid—to cover those fee increases for financially needy students. We have avoided making unallocated reductions, which can weaken the link between the Legislature’s intent and budget actions, thus harming budgetary accountability.

Figure 1 shows the main elements of our higher education budget proposal (excluding those that relate to Proposition 98 funding, which we discuss in the “California Community Colleges” section of this chapter). As the figure shows, our recommendations would result in General Fund savings of $553 million relative to the Governor's workload level.

Below we describe three main facets of our proposal: (1) accommodating enrollment growth, (2) adjustments to base budget, and (3) maintaining affordability for students. Because funding for the California Community Colleges (CCC) falls under the unique provisions of Proposition 98, we discuss CCC only summarily in this overview of our alternative budget, and present the fuller discussion of our CCC proposal in the “California Community Colleges” section that appears later in this chapter.  

Accommodating Enrollment Growth

We recommend the Legislature fund enrollment growth at all three segments based on our estimates of demographic change: 1.8 percent for the University of California, 1.6 percent for the California State University, and 1.7 percent for California Community Colleges.

Recent Enrollment Trends

Determining the amount of additional enrollment to fund each year can be difficult. Unlike enrollment in compulsory programs such as elementary and secondary schools, which corresponds 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 and unemployment rate) are, for the most part, beyond the control of the state. Others (such as higher education funding levels, fees, financial aid, and outreach programs) stem directly from state policy choices. Determining how all of these factors will interact to influence enrollment demand is challenging.

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. Most enrollment projections begin with estimates of growth in the potential student “pool” (18– to 24–year old population), which for the rest of the decade is expected to range from 1.6 percent to 2 percent annually.
• Participation Rates. For any subgroup of the general population, the percentage of individuals who are enrolled in college is that subgroup’s college participation rate. Participation rates can be affected by a variety of factors—state enrollment policies, the job market, and changes in the financial situation of students and their families.

Differences Between Actual and Budgeted Enrollment. The Legislature typically provides General Fund augmentations in the annual budget act to support specific increases in enrollment for all segments. Because the number of eligible students enrolling at the segments cannot be predicted with complete accuracy, the segments often enroll slightly more or fewer students than budgeted. For the current year, the University of California (UC) and the California State University (CSU) estimate they are exceeding their budgeted enrollment levels by about 3,200 and 10,000 full–time equivalent (FTE) students, respectively. No current–year estimates for CCC were available at the time this Analysis was prepared.

LAO Growth Projection. In order to project enrollment demand for 2008‑09, we calculated the ethnic, gender, and age makeup of each segment’s existing student population, and then projected separate growth rates for each group based on statewide demographic forecasts. In this way, we were able to account for different growth and participation rates of different demographic groups. We also assumed that each group’s participation rate would not change over the coming year. While we acknowledge these rates could change, they have been relatively flat over recent years and we not aware of any evidence to support alternative assumptions.

Using our demographic model, we project that enrollment demand will increase by 1.8 percent at UC, 1.6 percent at CSU, and 1.7 percent at CCC. The differences in these numbers reflect the different racial, gender, and age makeups of the three segments’ populations.

Governor's Proposal Would Not Ensure Growth Is Accommodated

The Governor's budget proposal nominally includes funding for 2.5 percent enrollment growth at UC and CSU, but then allows the segments to use all, or a portion of, this funding to backfill unallocated General Fund reductions. In fact, the Governor's budget requires only that UC and CSU enroll as many students in 2008‑09 as they were budgeted to serve in 2007–08. Because both segments estimate they currently are serving more students than they are budgeted to serve, the Governor's proposal would actually permit the segments to reduce enrollment from actual current–year levels.

For CCC, the Governor's proposal would provide funding for 1 percent enrollment growth. While this funding would be earmarked only for actual enrollment, it falls short of the 1.7 percent growth we project for CCC.

Fund Enrollment Growth to Accommodate Projected Increase

We recommend the Legislature fund budgeted enrollment growth of 1.8 percent for the University of California (UC), 1.6 percent for the California State University (CSU), and 1.7 percent for California Community Colleges. For UC and CSU, we recommend this funding be based on the Legislature’s marginal cost methodology. We also recommend the Legislature amend budget bill language to ensure the funding is used to support only new growth above the actual level in the current year. (Reduce Item 6440–001–001 by $16.4 million and Item 6610–001–0001 by $22 million.)

Fund Anticipated Growth. In order to ensure that the segments are able to accommodate all anticipated growth in the budget year, we recommend funding growth based on our projections of 1.8 percent for UC, 1.6 percent for CSU, and 1.7 percent for CCC. (Enrollment funding for CCC is more complicated than that for the universities. We discuss this and related issues in the “California Community Colleges” section of this chapter.)

Use Legislature’s Marginal Cost Methodology. The Governor's proposal bases UC and CSU growth funding calculations on a marginal cost methodology that the Legislature has repeatedly rejected. (The past two budget acts instead employ a compromise methodology adopted by the Legislature. For a comparison of these two methodologies, please see our Analysis of the 2007–08 Budget Bill (pages E182 – E190). For 2008‑09, the Governor's proposed marginal cost rates for each FTE student at UC and CSU are $11,274 and $8,173, respectively. Using the methodology adopted by the Legislature, however, the rates would be several hundred dollars lower for UC ($10,967) and several hundred dollars higher for CSU ($8,500). We used the Legislature’s methodology in our recommended enrollment funding levels for UC and for CSU.

Restrict UC and CSU Growth Funding to New Enrollment. As noted earlier, in the current year both segments are estimated to be serving more students than they are budgeted to serve. In order to accommodate those “extra” students, the segments have taken steps such as increasing average class size and redirecting funding from other areas of their budgets. We recognize that such steps are not desirable as a long–term strategy. However, given the state’s fiscal situation, we recommend that the segments continue to serve these extra students in the budget year. In other words, we recommend that any new growth funding be used exclusively to enroll additional students above the current–year level. Accordingly, we recommend the Governor's proposed budget bill language be amended to require UC’s enrollment to increase by 1.8 percent, and CSU’s enrollment to increase by 1.6 percent, from their actual current–year levels. Any shortfall in these enrollment targets would result in a corresponding reduction in the associated enrollment growth funding.

Adjustments to Base Budget

Responding to Price Increases

We recommend providing $49.5 million to the University of California and $45 million to the California State University to fund nondiscretionary cost increases. Given the state’s fiscal situation, we do not recommend funding salary increases at the segments. (Reduce Item 6440–001–0001 by $105 million and Item 6610–001–0001 by $101 million.)

In addition to augmentations for enrollment growth, the higher education segments customarily receive annual augmentations to compensate for the increased costs of labor and other operating expenses. For CCC, these cost increases are typically accommodated through the same statutory cost–of–living adjustment (COLA) formula that applies to K–12 schools. As a consequence of broader Proposition 98 considerations that we explain in the “California Community Colleges” section of this chapter, we recommend the Legislature not fund CCC’s or K–12’s COLAs in 2008‑09.

In contrast to K–12 schools, statute provides no guidance for funding cost increases at UC and CSU. Since the mid 1990s, the universities have entered into agreements with different governors (such as their current compact with Governor Schwarzenegger) that specify multiyear funding targets which include “base increases” to account for inflation, among other things. However, none of the past compacts has entirely been reflected in enacted budgets, as the segments have in some years received more, and in some years less, than called for in those agreements.

Proposed Unallocated Reductions Overwhelm Base Increases. The current compact calls for base increases of 5 percent for UC and CSU. Although such increases are included in the UC and CSU’s workload budgets, the Governor also proposes unallocated reductions of twice this amount for both segments. As a result, it is unclear how much funding would actually be available for cost increases.

Recommend Augmentations for Nondiscretionary Price Increases. In general, the universities face two kinds of potential cost increases: those related to (1) goods and services that are purchased from outside the university (such as utilities, equipment, and supplies), and (2) salaries and benefits for faculty, staff, and administrators that are employed by the university. We consider the first category of costs to be largely nondiscretionary in the short term. For example, as utility companies increase their rates, the universities are generally obligated to pay those higher rates. As these costs increase, therefore, the universities must either receive budget augmentations to cover these cost increases or they must redirect funding from other parts of their budgets. (This assumes that it is not feasible to cut back on the purchases themselves.) In other words, not including funding for nondiscretionary cost increases is tantamount to an unallocated reduction to other, discretionary programs.

For these reasons, we recommend the Legislature include funding in UC and CSU’s budgets to cover anticipated nondiscretionary cost increases. Although defining nondiscretionary costs can be a matter of some debate, we estimate that the segments will encounter nondiscretionary cost increases of $49.5 million for UC and $45 million for CSU.

Recommend No Employee COLAs. Given the state’s fiscal situation, we do not recommend the Legislature fund a COLA for UC and CSU employees. This is consistent with our recommendations for most employees at state agencies. We recognize that some UC and CSU campuses and programs compete in a national labor market for faculty. We also note that both segments have commissioned recent studies that found their faculty benefit packages were well above the average of their public and private comparison institutions.

Reduce Funding for Administrative Costs

We recommend the Legislature adopt the Governor's proposed reductions to the University of California’s and the California State University’s “institutional support” budgets. These budgets have been the subject of considerable controversy in recent years, and the universities are currently taking steps to reduce spending in these areas. (Reduce Item 6440–001–0001 by $32.3 million and Item 6610–001–0001 by $43.2 million.)

The Governor proposes 10 percent reductions to the workload budgets for UC and CSU’s institutional support budgets. These budgets include executive management and related administrative functions at the systemwide level and on campuses. Spending by both segments in this area—especially in the form of executive compensation—has been the subject of considerable controversy in recent years. The Legislature has held hearings on the subject and requested the State Auditor to investigate the segment’s executive compensation practices. In general, the Legislature and the Auditor found that both segments lacked transparency and violated their own policies in relation to executive compensation. In addition, legislative hearings revealed that the segments spend a larger share of their budgets on executive administration than comparable universities.

In the wake of these reports, both universities have taken steps to change their executive compensation practices, and UC is undertaking a major reorganization of the Office of the President. In light of these efforts, we believe UC and CSU should both be able to achieve the savings level proposed by the Governor.

Maintaining Affordability for Students

Up to this point, our analysis has considered the amount of funding needed to maintain higher education programs, including accommodating enrollment growth and covering nondiscretionary costs. We now discuss how that cost should be shared between students and the state.

Student Fees Contribute Toward Education Costs

California does not have a long–term policy for determining the respective shares of cost to be paid by the state and by students at each of the three segments. In 2003–04, the Legislature approved—and the Governor vetoed—legislation establishing fee and financial aid policy for UC and CSU (AB 2710, Liu). As passed by the Legislature, the bill established several principles:

• The cost of higher education is a shared responsibility of students, families, and the state.
• Changes in student fees should be gradual, moderate, and predictable, and should not exceed 8 percent in a given year.
• Fees should approach a fixed share of total educational cost at each segment, namely, 40 percent at UC and 30 percent at CSU.

Given the Governor’s veto of this legislation, the state still lacks a statutory fee policy. However, we believe that the principles noted above are helpful in thinking about student fees. (See the following box for some key findings and recommendations our office has recently made concerning student fees.)

Current Share of Cost. Figure 2 shows 2007–08 fee levels and the share of educational cost they cover for all three segments. As the figure shows, systemwide fees for California resident undergraduate students at UC are less than one–third of the total cost of education , while at CSU and CCC, systemwide fees are about one–quarter and one–tenth of the total cost of education, respectively. These fees apply primarily to non–needy students at each segment. As further discussed in the financial aid section of this piece, many students pay much less than the “sticker price” represented by these amounts.

Governor's Budget Envisions Unspecified Fee Increases for University Students

Fee Increases Were Part of UC and CSU Budget Requests. Last fall, UC and CSU submitted to the administration 2008‑09 budget proposals that reflected fee increases of 7.4 percent and 10 percent, respectively. Both segments delayed final decisions on student fees pending release of the Governor's budget and the subsequent response from the Legislature.

Governor's Budget Suggests Fees Could Increase Further. The Governor's budget package acknowledges that the universities may raise fees beyond the levels envisioned in their budget proposals in order to absorb proposed General Fund reductions. The Governor does not propose any specific fee level. However, his budget includes “placeholder” funding for the state’s Cal Grant program to cover maximum fee increases of 30 percent at UC and 33 percent at CSU.

We have two concerns about the Governor's approach to university student fees for 2008‑09. First, by deferring decisions on fee levels and the allocation of General Fund reductions to the governing boards, the budget proposal would remove the Legislature from key higher education budget and policy decisions. Second, the Governor's proposal treats fee revenue independently from other resources. This approach fails to acknowledge the interrelationship of funding sources in a context of shared responsibility.

Governor's Budget Would Leave CCC Fees Unchanged. The Governor proposes to maintain the current fee level of $20 per unit at the community colleges. Given the effect of inflation, the value of these fees (and the share of cost paid by students) would decline under the Governor's proposal.

Recommend Specific, Moderate Fee Increases

We recommend that the University of California and the California State University systemwide fees be raised 10 percent from their current levels in order to modestly increase the share of total education cost paid by non–needy students. (In the “California Community Colleges” section of this chapter, we also recommend a $6 per unit increase in California Community Colleges fees.) (Reduce Item 6440–001–0001 by $167.5 million and Item 6610–001–0001 by $108.7 million.)

Fee Increases Should Be Reflected in General Fund Appropriations. Given the state’s fiscal situation, we recommend that student fees be raised at UC and CSU by 10 percent, thus increasing somewhat the share of cost paid by nonneedy students at those segments. Although UC and CSU fee levels are set by the segments’ respective governing bodies, fee revenue is an integral part of the overall higher education budget adopted by the Legislature. Indeed, because this revenue is interchangeable with General Fund support, the fee increases would result in General Fund reductions of the same amount. We recommend the Legislature adopt budget bill language stating its intent with regard to UC and CSU fee levels, and making the segments’ General Fund support contingent on the expected fee levels. In this way, any fee increase above that intended by the Legislature would result in a dollar–for–dollar reduction in General Fund support.

Under our recommendation, the share of education cost paid by undergraduate students would increase from 31 percent to 34 percent at UC, and from 25 percent to 27 percent at CSU. This is below the upper limits the Legislature sought to establish in AB 2710. Fees at this level would also be well below the average of comparable public university systems. Moreover, our recommendations (below) to increase campus–based financial aid and Cal Grant awards would help ensure that these fee increases would not harm access for financially needy students.

Recommend Corresponding Increases to Financial Aid

We recommend increasing financial aid awards to reflect increased student fee levels. Specifically, as we discuss in more detail in the “California Student Aid Commission” section of this chapter, we recommend increasing Cal Grant funding and rejecting the Governor's proposal to phase out competitive Cal Grant awards. In addition, we recommend increasing institutional financial aid budgets by $32.5 million at the University of California and $28.5 million at the California State University. (Increase Item 6440–001–0001 by $32.5 million and Item 6610–001–0001 by $28.5 million.)

While we believe our recommended UC and CSU fee levels would be affordable to most students, they could create a hardship for financially needy students and their families. We therefore recommend several augmentations to financial aid support.

Cal Grants Would Cover Fee Increases for Many, but Not All, Students. The Governor's budget proposal offsets fee increases for many students through the Cal Grant entitlement program. The Governor proposes an augmentation that would cover fee increases of up to 30 percent at UC and 33 percent at CSU for Cal Grant entitlement recipients. However, the Governor also proposes to phase out the Cal Grant competitive program, which serves many financially needy students who do not qualify for entitlement awards.

Our alternative budget, like the Governor's, includes an augmentation to the Cal Grant program to fully offset fee increases. Our recommended augmentation is smaller than the Governor's, however, because our recommended fee levels are lower than the Governor's maximum fee levels. Unlike the Governor, we propose maintaining the Cal Grant competitive program to serve needy students. We also recommend augmenting that program for the fee increases. (Please see the “California Student Aid Commission” section of this chapter for a description of the Cal Grant programs and our detailed recommendations.)

Institutional Aid Bridges Some Gaps in State Financial Aid System. Both UC and CSU maintain “institutional aid” programs to supplement state and federal aid for their financially needy students. The segments generally allocate this aid based on financial need, but have a great deal of flexibility in how they measure need. For 2007–08, the University Student Aid Program (USAP) at UC is funded with $283 million, while the CSU’s State University Grants (SUG) program receives about $277 million.

Segments Lack Need–Based Methodology for Funding Institutional Aid. The segments have traditionally augmented institutional aid equal to a fixed proportion (usually one–third) of revenue generated from fee increases. For example, in 2003–04 UC increased fees sharply, resulting in over $300 million in added fee revenue. The university augmented institutional aid by nearly $100 million that year. This approach has resulted in large shifts in the criteria for allocating aid. In some years with large fee increases (and thus large increases in institutional aid), the segments have extended aid to students from families with relatively high incomes. In other years, they have tightened aid eligibility criteria, such as by increasing the expected contributions from students and families. While student need generally increases when fees are raised, the cost of covering that increased need is unlikely to match a fixed percentage of fee revenue each year.

Fee Waivers Protect Needy CCC Students From Fee Increases. Although CCC does not administer institutional aid, the CCC Board of Governors provides fee waivers for all needy students. This mechanism serves the same purpose as campus–based financial aid.

Recommend Augmenting UC and CSU Institutional Aid for Estimated Increase in Need. We recommend augmenting UC and CSU’s institutional aid budgets to cover our recommended fee increases for financially needy students whose fees are not fully covered by Cal Grants. We estimate this amount to be $32.5 million for UC and $28.5 million for CSU. For comparison, this amount is equivalent to 22 percent of combined new fee revenues (19 percent at UC and 26 percent at CSU). Our recommended funding for institutional aid is based on our estimates of student need resulting directly from fee increases, rather than an arbitrary proportion of new fee revenue, such as the traditional one–third.

In our alternative budget for CCC, we take into account the cost of continuing to waive fees for financially needy students.

Conclusion

Our recommended alternative budget for higher education achieves substantial savings relative to the Governor's workload level without unduly harming core educational programs. It fully funds our projections of enrollment growth; provides augmentations for nondiscretionary cost increases; and increases the share of cost borne by nonneedy students in the form of fees, while at the same time increasing campus–based financial aid funding and maintaining the integrity of the state’s Cal Grant programs. By avoiding unallocated reductions, our alternative budget provides a measure of budgetary transparency that is lacking in the Governor's proposal. It would also achieve $553 million in General Fund savings relative to the Governor's workload budget. In summary, we believe that our alternative budget provides a reasonable plan for funding higher education given the state’s fiscal situation.