Paying for Performance in Higher Education

It is no secret that the U.S. higher education system faces many challenges. For starters, the cost of college continues to rise. Another issue attracts less attention but is equally concerning: graduation rates remain remarkably low. Only 40 percent of first-time, full-time students graduate in four years, with just 60 percent graduating within six. Failing to complete college can leave students burdened by debt and without the wage gains and employment prospects that tend to accompany a diploma.

Traditionally, states have funded their university systems based on enrollment—meaning that funding levels are determined solely by the number of students that sign up for classes.

In response to these striking figures, many states have begun using their financing systems for public universities to incent graduation improvements through an approach known as outcomes-based funding (OBF). Traditionally, states have funded their university systems based on enrollment—meaning that funding levels are determined solely by the number of students that sign up for classes. This method has worked to promote access to the higher education system, ensuring that institutions have adequate resources to meet the demand for their services. OBF flips the script and instead allocates state funding based on a prescribed set of outcome measures, such as the number of graduates produced by a school. The objective is to nudge institutions towards investing more resources into improving completion numbers.

OBF has grown in popularity in recent years. Today, 32 states operate some form of OBF approach. One of the original—and most innovative—systems is Tennessee’s, which ties 100 percent of state funding (besides operational support) to a set of outcome metrics, such as the number of degrees produced and the number of students who are set to graduate on time. Tennessee also uses different sets of metrics for four-year and two-year schools, to reflect differences in the types of students who enroll, as well as the institutions’ varying missions.

Advocates of OBF claim that this approach works to align the incentives of institutions with those of students, compelling schools to double down on helping their students graduate. On the other hand, critics point out that OBF could create perverse incentives—like causing schools to raise admissions standards so as to not accept students who are less likely to graduate, or water down graduation requirements to boost completion numbers. Another potentially more serious problem is that institutions with poor outcomes are generally those in most need of resources.

Outcomes-based funding is not a silver bullet, but it offers the potential to align incentives and reward high-performing academic institutions.

Well-designed OBF approaches can work to mitigate these unintended consequences. For example, Tennessee has implemented a “quality assurance funding” system that operates alongside its OBF program. This system provides additional funding to institutions that demonstrate gains in student learning (via standardized testing), job placement, enrollment of low-income students (based on Pell eligibility), and a host of other metrics designed to ensure that schools are not gaming the system.

OBF is not a silver bullet, but it offers the potential to align incentives and reward high-performing academic institutions. Widespread low graduation rates mean that “business as usual” is no longer an option. Policymakers should continue to explore OBF and other approaches that can improve student outcomes and boost value in the higher education system.