Many educated Americans are surprised to learn that 70% of students enrolled in our colleges and universities attend state-supported institutions. This means that 70% of college students are not paying for the full cost of their education. We believe this was the right decision by state governments: higher education is a public good with many positive externalities and should be funded to the extent practicable. This premise reached its zenith in Clark Kerr’s three-tier system of UC, CSU and the community colleges, which has served as a cultural and economic beacon for decades.

With the unprecedented fiscal retrenchment at the state level since 2009, public higher education has been hit harder than ever, and nowhere has it been hit harder than in California. Last week, the California State University system announced it would have to freeze enrollment starting in the spring of 2013 due to the massive state budget cuts. And the week prior, one of California’s most prominent community colleges – Santa Monica College – which has had to eliminate more than 1,000 class sections since 2008 and which is facing additional cuts, announced it would establish a two-tier pricing structure. Currently, SMC tuition is $36 per unit (rising 28% to $46 this summer). The new pricing tier would be set at $200 per credit, and would come into play once budgeted sections are filled; those willing to pay the higher fees will be permitted to enroll, and the college will open up additional sections.

As higher education moves from a public good to a private good, the question is clear: what is the best way to ration a scarce resource? Rationing is a hard word, evoking “death panels” in healthcare, but it is hard to deny that rationing is occurring in California. Last year 137,000 California community college students were unable to get into a class they needed. A larger number were unable to apply for federal financial aid – not because Title IV funds ran dry, but because there weren’t enough counselors to help students complete applications. A panel established by California community college Chancellor Jack Scott has recommended rationing courses based on a student’s track record of remaining on a set programmatic pathway, rather than waltzing, wandering, stopping and starting.

But stop for a moment and consider what is being rationed. Right now, California’s public colleges are largely maintaining their low price points where demand vastly exceeds supply. The result is a classic shortage, which leads to the search for an approach to ration the available educational capacity. The bad news is that this shortage damages our economic competitiveness, as well as the prospects of every would-be student who is shut out of the system. The good news is that it is largely avoidable.

The UC system has largely avoided the fate of CSU and the community colleges because it has not bound itself to a single low price point. How so? Market rate tuition for out-of-state students. California’s leading public institution, UC Berkeley, has been busy in this regard. In response to budget cuts in 2009, Berkeley sent recruiters to Illinois, New York and Pennsylvania for the first time. Last fall, Berkeley sent nine admissions professionals on recruitment trips outside California. One recruiter, Ken Gonsalves, was profiled in the Chronicle of Higher Education last fall as having spent 10 days “trekking around Texas and Oklahoma [where] he shook hands with a couple hundred high school students and co-hosted breakfasts with dozens of high school counselors.” Randy Hodgins, former chief lobbyist for University of Washington, reports he once joked to a colleague at the University of California: “The answer to both our budget problems is, I take your kids and you take mine, and then they’re both nonresidents.”

What’s interesting about this is the perspective it provides on rationing. Institutions that price discriminate based on residence aren’t rationing educational capacity; they are rationing the state subsidy. In-state students receive a subsidy, while out-of-state students receive none. The difference is that rationing education capacity is the result of a shortage created by an artificial price ceiling, whereas rationing the subsidy allows for additional capacity; the effective price rises so the quantity demanded is equal to the quantity supplied.

Unfortunately, for CSU and California’s community colleges: out-of-state pricing is not a solution. Few students will travel from out-of-state to attend these schools, which serve a local population. Equally important, however, out-of-state pricing leads to some bizarre results. Consider the fact that students at the University of Texas have been encouraged by the financial aid office to buy a plot of land in West Texas in order to establish residence. At CU-Boulder in 2010, 1,389 out-of-state students filed petitions to be granted in-state status, and 90% were granted; the number of non-resident undergraduates is declining. Now a new company called Tuition Angels is marketing its “relocation” services to CU students, promising to do all the “heavy lifting” to help non-residents switch to in-state status. The company charges a 10% success fee – calculated on the student’s savings. The business owner, a 2007 CU graduate, wouldn’t provide the student newspaper with an interview because: “I have so many clients to get a hold of… an interview would be a distraction.”

Rationing subsidies based on residence is arbitrary, and becomes more and more tenuous as state subsidies diminish asymptotically as a percentage of overall revenue. At a certain point, you’d achieve an equally logical and fair result by rationing based on hair color or shoe size. A much better solution is to ration subsidies based on ability-to-pay. The good news is we already assess ability-to-pay through the Title IV process.

So CSU and California community colleges would be much better off investing in additional financial aid counselors, ensuring every prospective student completes the FAFSA, and then raising list tuition to a level that actually covers the cost of the education they provide. (In the case of Santa Monica College, this appears to be $200 per credit.) Then each school should be permitted to apply its subsidies from whatever source (state funding or donations) in the form of grants to students who otherwise would not be able to attend.

If at the end of this process, there are still thousands of students who are shut out, then Santa Monica College and its peers have two options:
1) Wait for the state to increase its subsidy (i.e., wait a very long time – like, forever long); or
2) Reengineer the way they deliver programs in order to reduce the sustainable tuition level to $150 or even $100 per credit – which would lead to much-needed innovation in higher education.

If the current set of “public” colleges and universities are unwilling or unable to innovate, states should consider providing their subsidies to other (i.e., private) institutions that deliver quality outcomes for low- or no-income students at sustainable tuition levels – in effect, creating a new class of public institutions defined based on performance rather than funding history.

So as public higher education transitions to a private good, CSU and California community colleges must stop rationing education and begin rationing whatever subsidies remain based on logical, defensible principles. Doing so means shifting list prices to market levels, which can be transitioned in over time. States and municipalities are doing just this as they usher in much less generous pension benefits for new hires, while protecting incumbent workers who are reliant on the higher – and unsustainable – benefit levels.

This is the only way to ensure that while public higher education won’t be available for everyone, it still will be available for the students who count i.e., students who wouldn’t have access without state support. And in an era where a leading public university like University of Virginia has a lower proportion of Pell Grant students than Yale (11% vs. 13%), and where according to a recent report in the San Jose Mercury News, grants provided by Harvard make attending that Ivy League school more affordable for middle-income families than CSU, nothing could be more important.

University Ventures (UV) is the premier investment firm focused exclusively on the global higher education sector. UV pursues a differentiated strategy of ‘innovation from within’. By partnering with top-tier universities and colleges, and then strategically directing private capital to develop programs of exceptional quality that address major economic and social needs, UV expects to set new standards for student outcomes and advance the development of the next generation of colleges and universities on a global scale.

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