Why are colleges facing financial difficulties?: The revenue-based portion of the story

 

The challenges noted by these three presidents are not specific to these schools. In late 2019, Moody’s Investor’s Service issued a negative outlook for the higher education sector due to across the board pressures on all of the revenue sources used by higher education institutions. For the vast majority of higher education institutions, revenues primarily come from two sources: the government and students.

Let’s take a moment to contemplate why revenues are unlikely to increase and may even decrease from these two sources.

Within the United States (and in many other countries), the financial outlook for state and federal governments are troubling. Before we explain why most outlooks are bleak, let’s quickly introduce you to the budgets for the federal and state governments. See the two figures provided from the Center on Budget and Policy Priorities which describes these figures in more detail for both the federal and state.

 

 

The first figure shows that most of the spending by the federal government goes to social security, health care (e.g. Medicare), defense, safety net programs, and interest on the debt. Education comprises a very small part of the federal government at 2%. Higher education makes up a larger portion of state budgets at 15%, slightly less than the amount spent on Medicaid, another program providing health care.

Now that you are thinking about governmental spending on higher education with pie charts in mind, let’s explain the governmental funding challenges by noting several points relating to the size of the overall pie and the share of the pie associated with each individual slice of the pie.

 

Point #1: Governmental revenues are unlikely to increase.

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[This slice of the pie is unlikely to increase.]

Explanation: Voters, especially those who vote in Republican primary elections, have punished many politicians in the past who have sought to increase taxes, so many politicians are very resistant to tax increases.

 

Point #2: Spending on Medicare, Medicaid, and Social Security is likely to grow.

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[The slices of the pie associated with Medicare, Medicaid, and Social Security will grow and form a larger share of the pie.]

Explanation: Medicare, Medicaid, and Social Security are entitlements, which means spending on them will automatically grow (unless laws are changed) when more citizens qualify for these services. Because people are living a longer number of years and the baby boom generation is reaching retirement age, more citizens will qualify for these services. Voters, especially those who vote in Democratic primary elections, have punished many politicians in the past who have sought to change the law so less is spent on these services, so many politicians are very resistant to proposing such changes.

 

Point #3: Spending on higher education is likely to decline.

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Explanation: If the size of the overall pie does not grow and certain slices do grow, then the other slices of the pie will need to shrink. Higher education is just as, if not more, likely to shrink as other spending categories as the public has become increasingly comfortable with college students covering an increasing share of their costs through tuition.

As the share of governmental spending that has gone to higher education has declined, many public higher education institutions have increased tuition and fee levels in order to replace governmental funds. Those increases will be described in lesson 11, so we will not cover them in depth here. We simply want to emphasize one point about those increases:

They have caused tuition to grow to the point where many schools are unlikely to be able to increase revenue by increasing tuition.

Further increases could lead to a reduction in the number of students who will enroll and/or an increase in the amount of financial aid that colleges and universities provide themselves. Both of these results will mean that although tuition levels would be higher at schools that raise prices, the actual amount of revenue the schools receive may not increase. Analyses often describe this phenomenon as an institution reaching their “price ceiling.”

As you learned earlier in the lesson, some higher education institutions rely upon private gifts and investment returns from past gifts to help cover costs. These sources of revenue, however, cannot solve the financial problems facing higher education. As you saw earlier when you compared the revenue profiles of different schools, only a subset of higher education institutions receive large amounts of funding from private gifts and endowment returns. Furthermore, donations are not projected to increase by close to the amounts needed to address the financial challenges facing higher education.

Because higher education institutions are unlikely to be able to increase their traditional revenue streams, many have sought to engage in new activities that generate revenue. The big question regarding these activities lies with whether they are mission-enhancing, mission-neutral, or detracting from the institution's mission. Many colleges and universities have created new educational programs that provide education through blended or online formats, which allows the school to expand enrollment. Such activities align with the traditional mission of the institution and simply provide education through new formats. Other activities, however, do not advance mission and could even detract from attempts to meet goals (See The Chronicle of Higher Education Article: Battle Over Colleges and Credit Cards Reaches Showdown in Iowa). For example, some arrangements between credit card companies and universities have been heavily criticized as enriching universities while encouraging students to go into debt. The individuals leading and working within universities who can identify and successfully enact activities that generate revenue while also advancing the mission will be in high demand as the financial challenges facing the industry continue to mount. The amount of entrepreneurial opportunities are not large enough to sustain all colleges and universities, but they may be sufficient to solidify the finances of a subset of schools.