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ED 15
Give Public Universities Increased Budget and Funding Flexibility

Summary

To compete effectively for talented students and research and development funding, universities must have some budgetary flexibility to adapt to changing circumstances. However, Texas public colleges and universities have only limited flexibility in setting tuition rates. State colleges and universities could gain additional resources if they were able to vary tuition charges to reflect factors such as program quality and demand, along with pricing strategies that encourage the most effective use of facilities. Moreover, universities are allowed to keep only 50 percent of funds collected for indirect costs incurred on sponsored research projects, while institutions in other states generally keep all of these funds and use them for new investments in research and development. Giving universities greater flexibility in setting tuition rates and allowing them to retain their indirect cost recovery funds would assist them in meeting the challenges of the 21st century.

Background

Tuition-Setting Authority

Texas public colleges and universities charge students both tuition and mandatory fees. There are two types of tuition: statutory tuition and “board-designated” tuition. As the name implies, statutory tuition is set by law, and for the 2002-2003 academic year is set at $44 per semester credit hour for undergraduate students. It will rise by $2 per semester credit hour each year until 2005-2006, when it reaches $50 per semester credit hour. Board-designated tuition, which prior to 1997 was called the “general use fee,” is set by university governing boards at an amount not to exceed the statutory rate. Prior to its redesignation as tuition in 1997, the general use fee was capped at $12 per semester credit hour for undergraduate students. Today, the maximum total tuition charge is $88 per semester credit hour. A number of Texas public universities, including the University of Texas at Austin, University of Texas at Dallas and Texas A&M University at College Station, charge the maximum rate.

In addition to tuition, students pay a variety of mandatory student fees. These fees are set by the governing boards of colleges and universities, generally within limits established by the Legislature in the statute authorizing each fee. Examples of mandatory fees are student union fees, student health center fees, and library fees. In general, mandatory fees fall into two categories, academic and nonacademic. Academic fees include, for example, the undergraduate writing lab fee at the University of Texas at Austin. Nonacademic fees are those that support auxiliary enterprises providing services for students, such as the student union fee or the student health center fee.

Texas is one of only a few states in which the Legislature plays a decisive role in determining tuition rates. According to an August 1999 survey of 40 states by the State Higher Education Executive Officers, 29 states grant primary authority for setting tuition to the university or the governing board of a university system. In five states, a state governing board or commission for higher education has primary authority. In three states, authority is shared between or among the governor, legislature, and institutional governing boards. Although the survey listed Texas as one of three states where the legislature sets tuition (the other two being Florida and Washington), the creation of board-designated tuition in 1997 means that boards of regents in Texas share tuition-setting authority with the Texas Legislature.[1]

One alleged advantage of maintaining legislative control over tuition is that it helps to hold down tuition and fee increases. However, even with legislative control, tuition and fees have risen substantially at Texas public universities. In 1992-93, the average undergraduate student taking 30 semester credit hours at a Texas public university paid $1,621 in tuition and fees. In 2002-03, that figure had more than doubled to $3,250.[2] This increase reflects a shift in state funding of public universities. In 1992-93, tuition and fees represented about 16 percent of total university revenue (excluding revenue from auxiliary enterprises, such as athletics and dormitories). Today, tuition and fees represented about one-quarter of university revenue.

States that have deregulated tuition authority still maintain a great deal of control over tuition increases. Universities know that if they increase tuition dramatically, the state legislature may reduce their state tax support. In addition, in Texas and elsewhere, universities are accountable to the governor and legislature because regents are appointed by the governor and confirmed by the state senate.

In practice, market forces play a key role in setting tuition levels. If a student feels that tuition at a state university is too high, he or she may decide to attend school elsewhere. Private colleges also play an important role. While private university tuition usually is much higher than public tuition, these institutions typically use a large portion of their tuition revenues to fund need-based financial aid. Thus they are able to compete for bright students by offering more generous financial aid packages than those available at public institutions. As a result, students with financial aid may pay less to attend a private institution than they would at a comparable public university.

One problem with Texas’ existing tuition structure is that it does not allow governing boards to use tuition policy to improve enrollment management; for example, by including incentives for students to take higher course loads or to take courses during the summer. Many universities in other states assess a flat rate for full-time students taking 12 or more semester credit hours per semester. Students who want to enroll for more credits than the minimum pay the same rate as students taking 12 hours, giving them an incentive to take more courses. Other universities set lower tuition rates during the summer session or between the traditional terms in order to make full use of facilities during these times. These policies allow universities to serve more students by encouraging them to complete their degree programs in less time.

Finally, by varying tuition rates among programs, governing boards can manage enrollment growth through pricing strategies. Universities can use tuition policy to help maintain enrollment at an optimal level. For example, boards of regents can lower tuition in fields where demand is greater than supply, such as nursing, in order to encourage enrollment growth in areas that are critical to the public welfare.

Nonresident Tuition Rate and Waivers

Since 1995, Texas has set the nonresident tuition rate at the state’s public universities at a level equal to the average of the tuition charged to nonresidents by the five largest states other than Texas (California, New York, Florida, Pennsylvania and Illinois). The Texas Higher Education Coordinating Board (THECB) sets the rate each January, based on rates in effect at the time. Before 1995, nonresident tuition was set at a rate that THECB determined would recover the average actual cost of education at these institutions.

In calculating the average tuition, however, THECB does not use differential rates based on different types of institutions or their missions. As a result, major research universities are treated the same as much smaller institutions in THECB’s calculation.

In recent years, Texas’ nonresident tuition rate has risen much more slowly than those of other states. This stands in sharp contrast to the rate of increase for resident Texas students. The state of Washington’s Higher Education Coordinating Board conducts a widely cited annual survey of tuition and fees, with tuition and fee averages reported for “flagship” universities and for a second group known as “colleges and universities.” The flagship institutions are major research institutions; for example, in Texas the University of Texas at Austin, Texas A&M University, and a few other universities with significant research programs would qualify as flagships. All other senior universities fall into the colleges and universities category in the Washington study. The study reports that UT-Austin resident rates rose by 28.9 percent from 1997-98 to 2000-2001. (UT-Austin was the only “flagship” university in Texas that was included in the survey.) This was well in excess of the national average increase of 21.1 percent at peer institutions.[3] At the other Texas colleges and universities Washington surveyed, resident tuition increased by 24.1 percent, versus a national average of 21.5 percent.[4]

Exhibit 1 compares nonresident tuition rates for a sample of universities in the six largest states, as well as the national average rate. The data show relatively little difference in the nonresident rate charged to students at the University of Texas at Austin, and the rates charged at nine other Texas public universities sampled for the survey. While the smaller Texas universities sampled in the survey charge nonresident rates close to the national average, UT-Austin charges considerably less than the national average for its peer institutions. Clearly, out-of-state students at Texas’ major research universities are receiving a bargain education compared to those at similar universities in other states.

Exhibit 1
2000-2001 Nonresident Tuition Rates and Four-Year Rate of Increase
at Selected Colleges and Universities in the Six Largest States

State Nonresident Rate - "Flagship" Universities Nonresident Rate - "Colleges and Universities" Four Year Percentage Increase at "Flagship" Universities Four Year Percentage Increase at "Colleges and Universities"
California $14,827 $ 9,279 11.2% 5.5%
New York $ 9,715 $ 8,981 5.1% 2.5%
Florida $10,332 $10,439 30.6% 32.0%
Illinois $13,574 $ 8,425 23.1% 1.6%
Pennsylvania $15,522 $10,305 25.1% 7.1%
National Average $12,140 $ 8,832 21.5% 21.4%
Texas $ 9,712 $ 8,980 0.1% 3.1%

Note: In Texas, the only “flagship” university included in the sample was the University of Texas at Austin. Nine other Texas public universities were surveyed for the “colleges and universities” comparison.
Source: Washington Higher Education Coordinating Board.

Texas waives nonresident tuition for out-of-state and foreign students who receive a competitive scholarship for more than $1,000 a year. These students must have competed against Texas students to receive the scholarship.

This waiver of nonresident tuition apparently is unique among states. It is designed to provide Texas universities with a recruitment incentive to attract top-ranked students. The number of students who may receive the waiver is capped at 5 percent of each institution’s total enrollment. Since the state reimburses the institutions for this lost revenue, it is a form of state financial aid. In fiscal 2001, Texas spent more than $45 million on nonresident tuition waivers.[5]

In recent years, the percentage of nonresident students at Texas universities has remained relatively constant; while the proportion of such students who are foreigners has increased (Exhibit 2).


Exhibit 2
Trends in Nonresident Enrollment, Texas Public Universities

Year Percent In-State Percent Out-of-State Percent Foreign
Fall 2001 89.3% 4.2% 6.5%
Fall 2000 89.5% 4.4% 6.1%
Fall 1999 89.7% 4.6% 5.7%
Fall 1998 89.8% 4.8% 5.4%
Fall 1997 89.7% 5.1% 5.2%
Fall 1996 89.7% 5.2% 5.0%

Note: Totals may not equal 100 due to rounding.
Source: Texas Higher Education Coordinating Board.

While there are valid public policy reasons for limiting nonresident tuition charges—not least of which is the cultivation of a diverse and accomplished student body—the state’s universities should be able to charge higher rates if they can continue to attract the students they want with the strength of their academic and research programs.

In a time of tight budgets, moreover, the state can no longer absorb the cost of waived nonresident tuition for students based on their receipt of a competitive scholarship. Institutions should be able to set nonresident tuition at a rate that allows them to pay for any waivers from their own institutional funds.

Indirect cost recovery

Colleges and universities that conduct sponsored research projects (those funded through grants from private companies or the federal government) use this funding to recover their direct costs—items directly associated with a project, such as salaries for faculty members and researchers and the cost of equipment purchased to conduct research.

Indirect costs are a different matter, in Texas at least. These costs, commonly called “overhead,” are incurred in eight major areas: building use/depreciation, equipment use allowance/depreciation, operations and maintenance, library, interest expense, departmental administration, general administration and sponsored research administration.

Indirect cost recovery is treated differently from state to state. Nearly all universities across the U.S., however, may use at least a portion of their indirect cost recoveries as “venture capital” to build research capacity and attract additional research projects to their campuses. The largest states, such as California, Florida and Michigan, allow universities to retain all or nearly all of the indirect costs they recover from sponsors to support additional research activities. A September 2000 survey by the University of Texas at Austin found that of the ten largest states, only Texas and Florida did not allow institutions to retain 100 percent of their indirect costs—and Florida allowed them to retain 98 percent.[6]

Texas law provides that funds received to pay for an institution’s indirect costs may be retained by the institution conducting the research and used to support additional research activities.[7] The law also provides, however, that the Legislature can reduce the amount of general revenue appropriated to that college or university by up to 50 percent of the indirect costs recovered.[8] The Legislature has chosen to take advantage of this option, offsetting the indirect cost recoveries colleges and universities receive by the full 50 percent. Only the state’s medical and dental institutions are allowed to retain the full amount received for indirect cost recovery.[9]

The rationale behind this decision is that these funds are collected to cover costs already accounted for in the state’s appropriations process. Some evidence suggests, however, that this may not be the case, and that allowing universities to retain all of this income may yield greater benefits to the state.

A recent RAND Corporation study found that while U.S. universities recover almost all of the direct costs associated with sponsored research projects, they recover only 70 percent to 90 percent of their indirect costs. Based on available data, the authors concluded that indirect costs account for about 31 percent of total costs, while the reimbursement rate is between 24 percent and 28 percent.[10] The study estimates that universities are being shortchanged by $750 million to $1.5 billion annually in overhead costs associated with federal research. The RAND study did not produce state estimates, but based on Texas’ share of federally sponsored research in 1997, the state’s indirect cost losses could be $40 million to $80 million annually. Universities that are not fully compensated for their indirect costs must supplement their research expenditures with other institutional funds.

Presumably, the state’s formula funding system reimburses universities for a portion of indirect costs connected with sponsored projects. According to the University of Texas System, however, the only formula element that recognizes research activities is the Space Support formula, which provides facilities funding. The system calculates that the formula amount generated under this item accounts for only 14 percent of the total indirect costs of research and, of this amount, only 70 percent is financed by general revenue funds. This tends to discount the notion that the funds should be returned to the state Treasury to reimburse the state for general revenue already spent.[11]

Texas might receive a greater return on its indirect cost recoveries by devoting more of these funds to additional research projects. According to the Comptroller’s economic input-output model, every dollar invested in research produces $3.32 in additional economic activity. Therefore, if the state redirected to research purposes the $35 million in annual indirect cost recoveries currently used to offset state support for higher education, the overall state economy would gain more than $115 million per year.[12]

In the state’s master plan for higher education, THECB has recommended that universities be allowed to retain all of their income from indirect cost recovery. This report, Texas Higher Education: Closing the Gaps, sets a state goal of increasing the overall level of federal science and engineering research funding at Texas universities by 50 percent, to $1.3 billion, by 2015. Although Texas recently moved from sixth to fifth place among states in federal research and development funding, several institutions in other states individually receive more intellectual property income (income from inventions, discoveries and works of authorship) than is received by all Texas higher education institutions combined.[13] Permitting institutions to keep all funds received from research sponsors, including indirect cost recoveries, could help further strengthen the state’s position as a research center.

Recommendations

A. The Texas Education Code should be amended to allow the governing boards of institutions of higher education to set tuition rates beginning with the 2004-2005 academic year, and to vary these rates as needed to effectively manage each institution.

Deregulation of tuition-setting authority should start with the 2004-05 academic year, since pricing and financial aid decisions for the 2003-04 academic year will be made before the beginning of the state’s fiscal biennium.

B. The Texas Education Code should be amended to make the existing nonresident tuition rate a minimum and allow colleges and universities to charge higher rates and retain any additional income produced.

Because tuition and fee rates for the 2003-2004 academic year will need to be set in early 2003 before the code can be amended, this change should be effective for the 2004-2005 academic year.

C. The current waiver of nonresident tuition for nonresident students receiving competitive scholarships worth more than $1,000 should be made voluntary for institutions. Any such waivers should be funded by colleges and universities rather than state general revenue.

The waiver of nonresident tuition for students receiving competitive scholarships can continue if a college or university governing board determines that it is in the institution’s best interests to offer the waiver as a recruitment and financial aid incentive. The cost of any such waivers should be borne by the institution. Colleges and universities should be able to compensate for the loss of state revenue by increasing nonresident tuition rates to cover the cost of any waivers they grant. Appropriations to institutions of higher education should be reduced by the amount spent on these waivers to yield savings to general revenue. Because tuition and fee rates for the 2003-2004 academic year are set prior to the beginning of the state’s 2004-2005 biennium, this change also should take effect with the 2004-2005 academic year so that institutions have the ability to adjust their rates to cover the costs of any waivers granted to nonresident students.

D. The Legislature should move toward allowing colleges and universities that conduct sponsored research projects to keep 100 percent of indirect cost recovery funds they receive. These additional funds should be spent to support research and development activities, as currently required by the Texas Education Code.

A phase-in of this change would give legislative budget writers time to adjust to lost revenues. The share retained should increase by 10 percent a year until it reaches 100 percent in 2008.

Fiscal Impact

Recommendation A may result in additional income for state colleges and universities. However, the amount of any increase depends on actions of the individual boards of regents and cannot be determined in advance. No reduction in state support for institutions of higher education is contemplated by this recommendation.

Recommendation B would increase revenue to the institutions, but the amount of the increases would depend upon the future actions of the governing boards of university systems and individual institutions and cannot be determined.

Recommendation C would result in a savings to general revenue in the amount of $45,443,033, based on the dollar value of the nonresident tuition waiver in fiscal 2001. These savings would not be realized until the second year of the biennium, since tuition rates for the 2003-04 academic year will be set under existing state law and waivers for that year will continue to be funded by the state. Appropriations to public universities should be reduced by this amount to produce savings to general revenue.

Recommendation D would result in a cost to general revenue. Phasing in the ability to retain indirect costs by increasing the percentage retained by 10 percent each year until it reaches 100 percent in fiscal 2008 would cushion the impact on state revenues. Based on estimated receipts for indirect cost recovery for fiscal 2003 as reflected in the General Appropriations Act, the additional cost to general revenue would be $7.1 million in fiscal 2004. Upon full implementation in fiscal 2008, the cost would rise to almost $35.6 million.

Fiscal Year Savings to General Revenue (Cost) to General Revenue Net Savings/(Cost) to General Revenue
2004 $0 ($ 7,113,000) ($ 7,113,000)
2005 $45,443,000 ($14,227,000) $31,216,000
2006 $45,443,000 ($21,340,000) $24,103,000
2007 $45,443,000 ($28,454,000) $16,989,000
2008 $45,443,000 ($35,567,000) $ 9,876,000


Endnotes

[1] State Higher Education Executive Officers, “1999-2000 Four-year Tuition Survey Summary” (Denver, Colorado, August 1999), Section A; and telephone interview with Hans L’Orange, director of Data and Information Management, State Higher Education Executive Officers Association, Denver, Colorado, December 19, 2002.

[2] Comptroller of Public Accounts, Texas Tomorrow Fund, “2002-2003 Survey of Senior Colleges” (unpublished data), June 26, 2002.

[3]Washington Higher Education Coordinating Board, 2000-2001 Tuition and Fee Rates: A National Comparison (Olympia, Washington, January 2002), Table 1.

[4]Washington Higher Education Coordinating Board, 2000-2001 Tuition and Fee Rates: A National Comparison, Table 5.

[5]Texas Higher Education Coordinating Board, 2001 Report on Fiscal Activities (Austin, Texas, February 2002), pp. 10-12.

[6]Survey conducted by the University of Texas at Austin Office of Institutional Studies, September 2000, and supplied by the University of Texas System Office.

[7]Tex. Educ. Code §145.001 (b).

[8]Tex. Educ. Code §145.001 (c).

[9]Tex. S.B. 1, 77th Leg., R.S. (2001).

[10]Rand Corporation, Paying for University Research Facilities and Administration (Santa Monica, California, 2000), p. xii.

[11]University of Texas System Office of Governmental Relations, Indirect Cost (Overhead Cost Recovery) (Austin, Texas, August 2002), p. 24. (Internal document supplied by UT System.)

[12]Texas Comptroller of Public Accounts, The Impact of the State Higher Education System on the Texas Economy (Austin, Texas, November, 2000), p. 9.

[13]Texas Higher Education Coordinating Board, Texas Higher Education: Closing the Gaps (Austin, Texas, October 2000), p. 16.