The Perfect Storm and the Privatization of Public Higher Education
Published on: Aug 17, 2006

At the federal level, the major growth in financial aid has been in loans and tax credits for college attendance, not increases in the level of Pell Grant awards. And massive federal deficits, both now and projected for the future-caused by recent reductions in federal tax rates, increases in military expenditures (at least in the short run) and the growing worries about future Medicare and Social Security trust fund deficits-make it unlikely that the federal government will be a future source of revenue to shore up our nation's public higher education system through substantial increases in needbased grant aid to students.

So increasingly, providing grant aid to maintain access to public higher education is becoming the responsibility of the public higher education institutions themselves.

Can Privatization Work?

While privatization policies have arisen at least partially from the budget problems that states face, as well as from policymakers' willingness to shift the costs of higher education from taxpayers to students, these policies also arise from the view that forcing the publics to behave more like the privates and compete for resources will lead to increased efficiencies and the elimination of waste. Meanwhile, as state support becomes an increasingly smaller proportion of their budgets, many public institutions want to be freed from governmental constraints that lead to inefficiencies in their operations and to have the freedom to make economic decisions that will improve their ability to compete with the privates.

The most important of these is the freedom to raise tuition to market levels. In the past, public universities typically raised their resident undergraduate tuition substantially only when state appropriations were cut during a recession, in order to partially offset the effects of the state cuts. But when they did, state legislatures and governors took the heat, thus generating political pressure to limit future tuition increases or even to roll back previous increases, as happened in Virginia and California in recent years.

Whether making formal agreements with the state to trade some level of state support for tuition control gives the publics more freedom is an open question. For example, the Miami University of Ohio moved to a high-tuition policy in the fall of 2004, charging resident and nonresident students the same tuition but promising each resident undergraduate student a grant at least equal to the state appropriation per student that it received. However, Miami's proposed increase in undergraduate tuition of 9 percent for fall 2005 was vetoed when the legislature and the governor capped resident tuition increases at 6 percent or $500, whichever was less. In Miami's case, it was $500, which translated into a 5.5 percent resident tuition increase.

Privatization policies vary widely and depend upon the specific circumstances of the state. For example, constitutional limitations on the growth of state expenditures, from which grants to students were exempt, convinced administrators of the University of Colorado system that they were better served by giving up much of their state appropriation in return for accepting a plan in which students would receive vouchers that could be used to partially offset tuition payments at state institutions. Inasmuch as the initial level of these vouchers was less than the cut in state appropriations per student that the university faced, the university had to negotiate a substantial increase in tuition as well. (See James Jacobs' article in Change, Jan/Feb 2006, for more about the Colorado experiment.)

Or to take another example, the Virginia General Assembly recently adopted legislation that grants public institutions additional authority over financial and administrative operations (including the freedom to raise tuition, within limits), but only after they make certain commitments to the state and only with appropriate accountability. Three levels of autonomy are available to institutions, depending upon their financial strength and management structure. (see Virginia Govorner Mark Warner's message in Change, Jan/Feb 2006, for a discussion of the Virginia plan.)

In judging the likely success of privatization efforts, it is important to understand how undergraduate and graduate education expenditures are financed. At private colleges and universities, the three largest sources of revenue are net tuition (tuition minus grant aid), endowment income, and annual giving. Public institutions have these three sources plus state appropriations.

Although the extra source of revenue would seem to advantage the publics, it does not. If state appropriations (or the vouchers that substitute for them) fail to grow or are cut back, a greater share of public institutions' educational funding must come from net tuition growth and increases in endowment income and annual giving. But while some flagship public institutions have substantial endowments and annual-giving levels, most do not. As John Wiley—the chancellor of the University of Wisconsin, Madison—has shown, most of them are unlikely to be able to generate the endowment and annual-giving levels that would be necessary to compensate for reductions in their state support. Hence while aggressively seeking increased endowments and annual giving may help, public higher education institutions trying to compensate for declining state support will have to devote most of their efforts to increasing their net tuition revenues.

The key work here is net. Increasing tuition by a given percentage does not guarantee that the total revenues generated by the tuition increase will increase by the same percentage, since a portion of those revenues goes to student aid, otherwise known as tuition discounts. Preliminary results from the 2004 annual NACUBO (National Association of College and University Business Officers) Tuition Discounting study suggest that freshman tuition discount rates average 38.6 percent at private colleges and universities in the United States, ranging from 41.1 percent at smaller low-tuition colleges to 30.5 percent at the larger private universities.

Moreover, except for a few highly selective private colleges and universities, these tuition discounts are not based solely on need but often on merit. Institutions use aid to boost their position on the prestige hierarchy by grafting a class with the desirable characteristics of high test scores and low need.