Running head: DESIGNING FUNDINGMODELS TO FIT STATE NEEDS

Designing Funding Models to Fit State Needs: A Hybrid Approach Bopharuth Cheng Seattle University SDAD 585 Summer 2013

DESIGNING FUNDINGMODELS TO FIT STATE NEEDS

It is clear that states will need to reexamine the fiscal appropriation process to budget for new federal initiatives and for todays changing economy. Counting on the days of regular streams of funds from state and federal aid is long gone. Looking ahead, there is only instability and fluctuation in state budgets as various human services, transportation and other priorities compete for state budgets. Considering that current state appropriations are unstable and no new funds are available, higher education is going to have to look into creative ventures to sustain growth and maintain affordability. States like Oregon, Michigan, Virginia, Louisiana, Iowa, Utah, and Washington have all started looking into a comprehensive reevaluation of everything from personnel policies to purchasing a closer look is being given to the basic structure of government, including consolidation of departments and elimination of boards and commissions wherever possible (Jones & Wellman, 2010). At this point, the fiscal climate appears to be grave; higher education should fight to keep current allocations and consider new approaches to state funding models. There is no one-fit-all funding model for higher education in the United States. Weerts (2012) addresses this matter regarding multiple variables that are known to be factors in state appropriations for higher education like: state fiscal health, demographics, competing state priorities, political climate and institutional characteristics. These factors make it difficult to implement a comprehensive funding policy at the federal level thus, states, institutions and local partnerships are the perfect storm to revise funding models at the state level. This paper provides an overview of three approaches to funding: 1) Performance-based funding, 2) Formula-based funding and 3) Responsibility center-based funding which then incorporates these three models into a hybrid approach and a proposed methodology for state level appropriations. A short

DESIGNING FUNDINGMODELS TO FIT STATE NEEDS

context on the cost of college is previewed before the proposal of designing a hybrid fund model. This paper will end with concluding remarks and pose a set of questions for stakeholders.

Literature Review: Three Policy Approaches to Funding Models During a time when access is no longer the central theme to higher education and the economy is poor, states have already begun looking into alternatives that will contribute to a healthy sustainable future for Americans. A deeper look into higher education reveals student completion rates are dramatically decreasing over the last several years. In addition, state budget cuts have deepened for higher education institutions. At the same rate, increased student enrollments from diverse backgrounds including those from low-income families and historically underrepresented communities are entering college requiring more and different types of help. A call for more money to be invested into human capital should be prioritized. The success of our future college graduates is essentially an investment into a sustainable economy and growth for states as well as all Americans. Current funding models need to be reexamined to meet this goal. This section will describe three funding models that are currently in practice to some degree by various states and higher education institutions.

Performance-Based Funding The Performance-Based Funding (PBF) model emerged in the late 1970s and became popular during the economic boom of the 1990s when states had extra revenue (F. Ashby, personal communication, June 26, 2013). At the time, a little more than half of the states tested the PBF model and by 2007, fourteen states abandoned this project after identifying key factors that needed design improvements. The design flaws were: allowing flexibility for various

DESIGNING FUNDINGMODELS TO FIT STATE NEEDS institutional types, recognition of progress that institutions have made (based on student success and advancement rather than solely on enrollment) and assessing whether if the reward funds is strong enough to be considered as an incentive for the institution (Miao, 2012). PBF is an incentivized system that rewards institutions for meeting outcome-based goals like graduation rates. A research report by SRI International (2012) for the Nevada State Legislatures Committee to Study the Funding of Higher Education found thirteen states currently utilizing PBF, six states plan to implement the model and twenty states have discussed this option. If all states that are considering adopting PBF from SRI Internationals report implement this funding model then that would make more than 75% of the United States using some form of PBF. It

would be interesting to study whether if state economies have an influence on the PBF adoptions and whether if these incentivized funds are additional dollars for the institutions or a percentage of currently appropriated budgets. The possibility of this high rate of adoption reveals some highlights of the PBF model yet states must also be vigilant about the drawbacks. Highlights of this approach involve higher productivity in a sense that focus is shifted to student success rather than merely enrolling students. In addition, this model strengthens state priorities and provides transparency (Barr & McClellan, 2011). On the other hand, Shins (2010) research found that graduation rates did not differ in states that implemented accountability models like PBF when compared to states without these programs. Despite this study, there is limited research on PBF operations; continued analyses of these programs are recommended to accurately depict the full impact of this model. Key elements of PBF include: Accountability is placed on the institution for ensuring student success.

DESIGNING FUNDINGMODELS TO FIT STATE NEEDS Performance is measured by defined outputs i.e. degrees awarded, transfer rates, remedial course completion, student progression, etc

Incentives and rewards are given to institutions for meeting benchmarks and/or goals set by governing boards or at the state level.

Formula-based Funding The Formula-Based Funding (FBF) model is widely used in state-level allocation of funds for public higher education and has been in effect for more than half a century (McKeownMak, 1999). Although FBF has a long-standing history in the United States, likely due to its simplistic characteristics, it may no longer be the only desirable choice or practical means for calculating budget appropriations. This funding approach uses mathematical computations to distribute funds to various institutions based on enrollments (FTEs or full-time equivalents) and other institutional costs such as salaries, support services, building operations and maintenance (Barr & McClellan, 2011; McKeown-Mak, 1999). Currently, seventeen states use FBF as their primary funding model while fourteen states use a hybrid model of the FBF (SRI International, 2012). The FBF uses various criteria to compute funding amounts, for example, enrollment, building square footage, faculty, credit hours, library, retention rates and research (Barr & McClellan, 2011; SRI International 2012). Like PBF, the FBF model has positive and negative components to its structure. Positive components are equitable and transparent budgeting practices, which allow colleges and universities to focus on meeting formula goals. However, colleges and universities may get fixated on meeting the goals of the formulas rather than taking a holistic approach to the purpose

DESIGNING FUNDINGMODELS TO FIT STATE NEEDS of the goals. For example, formulas based on FTEs means increased access, which is favorable, but not at the cost of graduating students. Key elements of FBF include: Transparent state budget appropriations and institutions allocation of funds. Simple computational design that can be easily be implemented across all levels of higher education. While the actual formula can be straightforward or complex. Normally driven by student enrollment.

Responsibility Center Base The Responsibility Center Base (RCB) funding model is a fairly new approach to budgeting for universities. Many public higher education institutions use fund accounting, which mainly tracks expenditures while RCB requires responsibility of a budget manager with overall accountability for achieving the units financial targets (Vonasek, 2011). RCB was introduced in the 1960s by Harvard University through application of the Every Tub on Its Own Bottom [concept] (Vonasek, 2011). The RCB is also known as value centered management, decentralized budgeting, activity-based budgeting, value responsibility budgeting and cost center budgeting (Vonasek, 2011). In simple terms, units are seen as either revenue centers or cost centers (Barr & McClellan, 2011). This type of budgeting is more commonly practiced at the institutional levels because revenue-generating programs can keep a portion of their earned money while reinvesting some money back into the pot for the general purpose of the institution. However, from a states perspective, RCB could be implemented at the state level mainly taking on the appeal of a decentralized approach to funding.

DESIGNING FUNDINGMODELS TO FIT STATE NEEDS Again, there are positives in the RCB model while taking into account pitfalls of this approach. Positive linkages to this model are shared responsibilities for creating a culture of

transparency and accountability as well as forward thinkers on how to best bring in revenue. This would be a good model for large public institutions where their missions and goals include research and innovation. Apparent pitfalls of this model are extreme cases of decentralization where programs are competing to offer similar courses; the notion that my earnings are your earnings may lead to revolts by programs that consistently produce revenues while other areas of the institution are piggy-backing on their efforts. Key elements of RCB include: More flexibility granted to institutions in hope for increased productivity and increased levels of innovation. Decentralized governance of fund allocation like allowing for carry-over funds, ability to invest those funds, reverse restrictions of funds etc. Units that produce revenues get to keep a percentage of it while a certain amount is put back into the general funds pool to be reallocated. Requires high levels budget manages to make responsible-ethical decisions that align with the institution mission this could lead to a stressful work environment.

Cost of College Who Should Pay? Tuition plays a large role in higher education and sometimes it is the determining factor for students that choose to attend college or go directly to work. Badolato (2008) uses a metaphor to assert tuition policy setting guidelines stemming from three areas like a three legged stool 1) higher education finance 2) state appropriations and 3) financial aid. Badolato is saying

DESIGNING FUNDINGMODELS TO FIT STATE NEEDS not one entity can solve rising costs of colleges; this is an effort requiring alignment from all spectrums of the government. In the past decade, the responsibility of college costs has shifted its burden onto students and families. Not only does this create a barrier for families who cannot afford college but also puts a strain on college graduates who have accumulated insurmountable levels of debt. Since states have cut budgets in higher education, since federal aid has been

scaled back and since higher education has increased tuitions to offset regular streams of revenue from both state and federal levels it is no surprise that students are hit with the bill. What about new funding models that pulls in a very lucrative segment of our economy that has not been mentioned yet? What about seeking-out businesses, corporations, private organizations and nonprofit funders for funding sources or creative partnerships? In a state like Washington, we should ask why policy makers continue to afford tax cuts to wealthy businesses. These businesses like Microsoft and Boeing should invest in our college graduates future to promote a qualified workforce for their industries. Some partnerships currently take place, however policies and mandates are necessary drivers to sustain these new funding sources. To answer the question, who should pay for college? This is an abstract question that takes into consideration many factors, which are largely out-of-control of an average college freshman. Which begs the question for why they are taking on a burden of the costs? If that is the case, then employers should be ready to hire these college graduates and institutions should be preparing them for a skilled workforce. Otherwise, who will or are filling these jobs? Not to mention, there are greater systemic issues at hand that contribute to our current fiscal climate like the widening gap between the rich and middle-income families. Let us turn this conversation to industries that make billions of dollars. Are they doing their due diligence in contributing to a

DESIGNING FUNDINGMODELS TO FIT STATE NEEDS sustainable and an equitable economy, how can a small portion of their dollars help in their future employees tuition? The cost of college is not solely a tuition issue; it is the issue of our states, taxpayers,

public and private universities and colleges, our families, businesses and corporations. Providing access to college through fully funded (phrase is used loosely here) education may no longer be the right target points, because college enrollment is growing and so is competition for state funds. As we move forward into a new fiscal climate, providing access and producing successful college graduates will be a challenge if no change is made. Like Miao (2012) states, its time to rethink the current postsecondary funding model.

Funding Proposal This funding proposal incorporates several principles that place value on higher education as an investment tool for all Americans. The main premise of this model lies on the fact that states and institutions need to find new revenue sources. While lobbyists and higher education administrators continue to fight for increased appropriations, the reality of the matter is that increased funding is not going to happen. States across the nation have seen budget cuts for the past two decades and even though the economy has slowly bounced back, higher education resources have not returned to the pre-recession levels (Jones & Wellman, 2010; Oliff, Palacios, Johnson & Leachman, 2013). States and institutions should work together to compact new models and new policies that will ensure sustainability, equity and accessibility for higher education. Additionally, institutions should focus on success and the student achievement of future college graduates. Moreover, increased efficiencies at both state and higher education levels should be reexamined by surveying the state landscape for current resources and

DESIGNING FUNDINGMODELS TO FIT STATE NEEDS

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productivity areas. A key highlight of this model looks to resource areas in building partnerships and joint ventures with large businesses, industries, organizations and other public colleges and universities. An incentive for companies and private businesses are investments in our college graduates for qualified-skilled workers and a culture of innovation. This essentially sets-up college graduates to be directly aligned with employer needs for qualified and skilled workers. This multi-level enterprise brings forth a foundation rested upon state, institutions of higher education and businesses. Thus, a hybrid approach is proposed for todays fiscal climate. This hybrid approach pulls from the FBF, PBF and RCB models; which combines formula computations for base funds measured by FTEs, performance measurements based on completion of degree and a decentralized approach to allow flexibility yet placing institutions at higher accountability. The principles that drive this hybrid model are: States and institutions build compacts that address minimum funding thresholds that is set for variable state economies such as when state budgets are in excess or deficit. The minimum fund threshold is to ensure higher education still gets a piece-of-the-pie in any fiscal environment. Grant institutions more autonomy and flexibility with the current state appropriated funds. This can be done through a decentralized approach where institutions are responsible for a portion of their revenue through external funding sources like business partnerships and joint ventures, auxiliary accounts and research. Higher education is treated like an investment to the state, thus linking core initiatives to be aligned with state economies and goals. This drives both tuition dollars and

DESIGNING FUNDINGMODELS TO FIT STATE NEEDS policy when connections are made for stakeholders like business-industries, profit and non-profit funders and taxpayers at-large. Incentivize institutions that meet benchmarks set by the state and the institution in areas of performance and innovation in efficiencies. Performance measurements include both outcomes-based (i.e. degrees awarded, graduation rates, transfer rates, etc.) and/or progress-based (i.e. retention rates, remedial course completion,

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successful momentum points, etc). Innovation in efficiencies measurements include cost-savings processes and procedures that boost operations; major incentives for utilization of technology advancement. Institutions are accountable and transparent in their budget management. Formulas are used to calculate a base budget for the instructional costs and should include a set percentage rate that offsets the PBF percentage. Institutions will be able to keep a portion of their generated revenue and be able to carry-over any unused funds; however provisions should be made when institutions are not meeting performance benchmarks. The incentive for working harder is a bigger picture outlook for a flourishing economy that sparks innovation, creativity and knowledge. In this theory, this hybrid model accounts for many systemic issues in our higher education system; however, there are shortcomings of all situations. Apparent concerns for this model include the balancing act between a state council that oversees higher education institutions and a decentralized level of state appropriation. This hybrid model will need a lot of fine-tuning and a considerable amount of time to perfect but assessment cannot take place until there is data to evaluate. Not to mention, a radical culture shift at the institutional level is

DESIGNING FUNDINGMODELS TO FIT STATE NEEDS required to carryout initiatives like generating own revenue sources and refocusing goals to

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attain degree completion versus enrollment. On the other hand, a hybrid approach is a contender as states race to find the perfect funding model. Conclusion While there might be a race to find the perfect model, the Demos report (2012) and Weerts and Ronca (2012), do not believe in a perfect model scenario because it is important for states to determine a funding model that will work for their system and it is notable that there is no one-fit-all model. States appropriation is at a dead end, federal aid is depleting and higher education is at a crossroads; great opportunity lies before higher education institution if timely action occurs. As noted in this paper, there are various funding models and three were highlighted here; a combination or hybrid model may be a likely contender for states consideration. Who says that policy reforms have to be traditional and stick to one modality? This is a proposal to state policy makers to consider multiple options when developing funding models. It is essential to consider factors that are germane to the state and its competition in a global workforce. We should really ask ourselves these hard questions when making policies and acknowledge the multi-level effects when making those decisions. What are the risks for greater flexibility and autonomy of colleges and universities and does possibility of benefits outweigh the risks? Are policy-makers selling-out higher education when multiple tax-cuts are given to wealthy businesses and corporations? What exactly are the goals of the state and how much influence do wealthy businesses have on swaying policy-makers votes? What does that do the goals of the states and ultimately higher education?

DESIGNING FUNDINGMODELS TO FIT STATE NEEDS Who should set tuition prices and who should pay for college? What are other countries doing and why are we only studying what other states are

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doing? Higher education prides itself on being globally connected but we rarely choose to assess other countries best practices.

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American Association of State Colleges and Universities. (2012, July). Update on the federal maintenance effort provision: Reinforcing the state role in public higher education financing (Policy Brief retrieved http://www.aascu.org/policy/publications/policymatters/2012/MaintenanceofEffort-II.pdf). Washington DC: Harnisch, T.

Barr, M.J., & McClellan, G.S. (2011). Budgets and financial management in higher education. San Francisco, CA: Jossey-Bass.

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Jones, D., & Wellman, J. (2010). Breaking bad habits: Navigating the financial crisis. Change The Magazine of Higher Learning, May/June. Retrieved from http://www.changemag.org/Archives/Back%20Issues/May-June%202010/breaking-badfull.html

Miao, K. (2012). Performance-based funding of higher education: A detailed look at best practices in 6 states. Retrieved from Center for American Progress website: http://www.americanprogress.org/issues/highereducation/report/2012/08/07/12036/performance-based-funding-of-higher-education/

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Oliff, P., Palacios, I. J., & Leachman, M. (2013). Recent deep state cuts may harm students and the economy for years to come. Retrieved from Center on Budget and Policy Priorities website: http://www.cbpp.org/cms/index.cfm?fa=view&id=3927

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http://www.wsac.wa.gov/sites/default/files/HEFTF_WEBREPORT_COMPRESSED122 910.pdf

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