LAO Puts Higher Ed in the Freezer

The Legislative Analyst's Office (LAO) released its budget outlook for the coming year and the next few years.  Good cheer generally, except for higher ed.  Revenue is up more than projected.  (Recall the governor insisted on "conservative" forecasts last June.)  Spending is up, too, but the net points to a rising state reserve.  Indeed, the LAO simulated a mild recession and thinks we could pull through without another calamity.

However, when in comes to spending on higher ed, UC is frozen at $2.8 billion indefinitely.  No adjustments for inflation and enrollment growth (which LAO doesn't think will happen based on demographics).  The LAO mentions the possibility about the state taking some interest in the UC pension, but only mentions it.  It doesn't recommend it.  LAO does note that its freeze doesn't accord with the governor's multiyear plan for UC and CSU.  We reproduce the higher ed portion of the LA report below.  The full report is at:
http://lao.ca.gov/reports/2013/bud/fiscal-outlook/fiscal-outlook-112013.pdf

Higher Education

In addition to community colleges (which are part of the Proposition 98 forecast), the state’s higher education system includes CSU, UC, and California Student Aid Commission (CSAC). The CSU educates about 430,000 undergraduate and master’s students at 23 campuses. The UC is a comprehensive research university educating about 240,000 undergraduate, master’s, and doctoral students at ten campuses. Both universities receive support for their core instructional programs primarily from a combination of state funds and student tuition revenue. The CSAC is responsible for administering state financial aid programs—most notably, the Cal Grant program—with support from the state General Fund, federal Temporary Assistance for Needy Families (TANF) funds, and the Student Loan Operating Fund (SLOF).

Assumptions 

Forecast Sensitive to Underlying Assumptions. Unlike many other areas of the state budget that are constrained by constitutional or federal requirements, the Legislature has significant discretion over university and financial aid expenditures. At the same time, the universities have greater control over their total operating budget than most state agencies because they have the ability to raise additional revenue by increasing student tuition. These factors mean that expenditures on the universities and financial aid are very sensitive to future legislative actions and the systems’ future decisions on tuition levels.

Assumes No COLA or Enrollment Changes for Universities. Our forecast assumes the state does not provide COLAs for the universities, consistent with state law regarding no automatic COLAs for most state programs. In addition, we assume no enrollment changes at either CSU or UC. Changes in enrollment at CSU and UC typically are driven by changes in the college–age population and the universities’ eligibility policies. Our demographic projections show declines in the traditional college–age population in each year of the forecast period, with the number of 18–24 year olds 7 percent lower in 2020 compared to 2014. Regarding the universities’ eligibility targets, the state’s Master Plan for Higher Education calls for CSU and UC to draw from the top 33 percent and 12.5 percent of high school graduates in the state, respectively. Though the state no longer conducts eligibility studies, recent research from the Public Policy Institute of California (PPIC) suggests that both universities are drawing from beyond their Master Plan eligibility pools. Both CSU and UC, however, report unmet enrollment demand. CSU reports more than 20,000 eligible students annually being denied admission in recent years, while UC reports an increase in the number of eligible students being denied admission to their preferred campus. The apparent conflict between the PPIC study and university admissions reports may result from different ways of measuring the eligible pool of students. Though a more refined study examining CSU and UC’s current eligibility, admission, and enrollment trends would offer the Legislature better guidance in making enrollment decisions, the totality of available data suggest CSU and UC enrollment pressures will be low over the forecast period.
Assumes No Participation or Award Changes for Cal Grants. Our forecast also assumes no changes in Cal Grant participation rates. Cal Grant participation historically has been driven primarily by the number of high school graduates in the state, though the number of students completing federal financial aid applications and the condition of the economy also can influence Cal Grant participation. The number of high school graduates is expected to decline somewhat over the forecast period. The number of aid applications, which has grown significantly in recent years, also appears to be leveling off. Though we assume flat Cal Grant participation over the period, significant improvement in the economy—especially in employment—could somewhat reduce future demand for financial aid. Our forecast also assumes no changes in Cal Grant award amounts. Cal Grant award amounts would increase automatically only if tuition at UC and CSU increased during the forecast period.
Assumes Continued General Fund Offsets. In recent years, the state has used two funding sources—TANF and SLOF—to offset some General Fund Cal Grant costs. Our forecast assumes the state continues to use $542 million in TANF funding annually throughout the forecast period for Cal Grants. We also assume the state continues to rely on SLOF contributions for the next two years. The SLOF, which is funded by proceeds from California’s federal student loan program, helped to support Cal Grant costs in some years prior to the loan program’s 2010 transfer to Educational Credit Management Corporation (ECMC)—a national loan servicing organization. As part of the transfer, ECMC agreed to continue sharing a portion of its proceeds for a few years. ECMC set a goal of $500 million in total contributions for Cal Grants, has paid $345 million since 2010, and has signaled its intention to make two additional contributions. Accordingly, our forecast includes $77 million SLOF support in each 2014–15 and 2015–16, followed by a General Fund backfill of this amount in 2016–17.

Forecast

State Spending on Universities Projected to Be Flat Over Entire Forecast Period. Specifically, we project that state spending for CSU and UC will be $2.2 billion and $2.8 billion, respectively, each year from 2013–14 through 2019–20. (Consistent with current state policy, our forecast assumes that spending on debt service for state–supportable capital outlay projects at UC is paid from UC’s support budget, while CSU’s state–supportable debt–service costs are paid separately by the state and included in our statewide debt–service projections.)
State Spending on Cal Grants Also Flat. Following steady increases that have more than doubled Cal Grant expenditures since 2007–08, we expect costs to remain relatively level at $1.7 billion over the forecast period. This forecast reflects our baseline assumptions regarding enrollment and tuition, as well as cost increases and savings resulting from prior–year policy actions. The California Dream Act of 2010—Chapter 604, Statutes of 2010 (AB 131, Cedillo)—makes some nonresident students eligible to receive state financial aid beginning in 2013–14. Dream Act costs will increase as current recipients renew their awards and additional cohorts of high school graduates and community college transfer students qualify for new awards. We anticipate these costs will level off at about $85 million beginning in 2016–17. These cost increases are largely offset by savings resulting from two policy changes enacted in recent years: (1) reductions in Cal Grant maximum award amounts at private colleges and universities and (2) the phase out of loan assumption programs for teachers and nurses.
New Scholarship Program Drives Budget Growth. The 2013–14 budget package created the Middle Class Scholarship Program, a new financial aid program for certain CSU and UC students. Under the new program, students with family incomes up to $150,000 will qualify for scholarships that cover up to 40 percent of their tuition (when combined with all other public financial aid). The program is to be phased in over four years, beginning in 2014–15. Budget legislation provides $107 million for the program in 2014–15, $152 million in 2015–16, and $228 million in 2016–17, with funding for the program capped at $305 million beginning in 2017–18.

Other Budgeting Approaches

Governor’s Multiyear Funding Plan for the Universities Would Increase Costs Significantly. Though our forecast shows no increases in state spending on the universities over the coming six years, the Governor already has indicated an interest in augmenting the universities’ budgets. As part of his 2013–14 budget plan, the Governor proposed providing CSU and UC with an unallocated base increase of 5 percent in 2013–14 ($125 million for each segment) and 5 percent in 2014–15 ($142 million for each)—followed by 4 percent increases in 2015–16 ($120 million each) and 2016–17 ($124 million each). (The proposed increases are the same for each university because the Governor bases them both on UC’s budget.) The final budget package included only the base increase for 2013–14 without any commitment by the state for out–year funding. Nevertheless, our understanding is that the administration intends to maintain the multiyear plan in 2014–15. If the Legislature were to adopt the Governor’s plan, state expenditures on both universities combined would increase by $284 million above 2013–14 levels in 2014–15, growing to $772 million annually by 2016–17.
Legislature Could Take Alternative Approach and Consider Funding Universities’ Main Cost Drivers. During last year’s budget deliberations, we expressed various concerns with the Governor’s multiyear funding plan—such as the rationales for providing the specific base increases proposed for CSU and UC and for treating the two university systems identically. The Legislature could take a different, more traditional approach to building the universities’ budgets that focuses on major cost drivers, including deferred costs and inflationary pressures. One particularly notable deferred cost is UC’s unfunded liability in its pension plan. If the Legislature were to provide the full amount requested by UC to fund these liabilities, state costs for UC would increase by over $230 million annually.
Addressing Inflationary Pressures on University Budgets. One main cost driver for the universities is inflation. In 2014–15, inflation is estimated at 2.2 percent. (Throughout the remainder of the forecast period, inflation is projected to hover around 2.5 percent.) In the past, we have recommended that inflationary cost increases be shared by the state and students (in the form of tuition increases). This provides an incentive for students to hold universities accountable for cost increases. Augmenting state funding for the universities by 2.2 percent in 2014–15 would cost a total of $111 million whereas increasing student tuition at the universities by 2.2 percent would generate a total of $96 million in additional tuition revenue. (Higher tuition would indirectly increase Cal Grant awards for CSU and UC students. Of the $96 million, $26 million would come in the form of larger Cal Grant awards.) The universities could use this COLA–related funding to cover a number of cost increases, such as those related to health care premiums, utilities, and faculty and staff salaries. In addition, UC could use its funding to cover increased debt–service costs.
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Unfortunately, the LAO wants to leave us frozen in the cold, where really bad things can happen: