Building Higher Education Rainy Day Funds

Proposed interventions for the college affordability crisis tend to be as complicated as the issue itself. College prices are generally set by institutions with little oversight, though at community colleges and public universities in some states, tuition may be set by entities directly or indirectly answerable to voters. The price of college varies from institution to institution and from student to student—from students paying out of pocket or taking big student loans at pricy private colleges to public community colleges where some students pay zero tuition thanks to state legislative intervention. The federal government’s role in paying for college has largely been to provide student aid that “follows the student” and can be spent at most institutions: Pell Grants for low-income students, federal student loans, and aid to military personnel and veterans. The federal government has also been a funder of last resort during economic crises, providing emergency aid to states and colleges to alleviate the impacts of the Great Recession and the COVID pandemic on higher education systems.

The federal government should take a more direct role in bringing down the cost of college for students by providing flexible block grants to states—with strings attached. To incentivize states to invest in college affordability, the federal government would provide a large infusion of federal matching grants, which would partially be used to bring down the price of college as the state sees fit: through student grants, direct funding of public institutions (to bring down tuition and other costs), or through College Promise programs. This funding stream would also go towards the creation of “rainy day funds,” which can provide a buffer for state higher education spending in the event of future economic recessions, thereby avoiding the need for large infusions of federal emergency spending.

What is a rainy day fund?

BPC has advocated for using some of this new funding to stabilize state investment in higher education during recessions by creating rainy day funds that states could draw on when their budgets take a hit. This would help prevent the tuition hikes that have occurred during prior recessions as well as avert long-term state disinvestment in higher education.

The strings attached to these new flexible block grants to states would include maintenance of effort provisions to ensure that states increased their investment in college affordability rather than simply moving money around. Limitations on how and when states could draw on the rainy day funds would also be necessary in order to ensure that a rainy day fund for higher education was not used as a slush fund to fill other budget gaps.

How much money would need to be invested in state rainy day funds?

In previous recessions, state higher education spending has taken notable hits, with spending dips of 15-25% being typical. As such, to meaningfully compensate for such drops, the size of a state rainy day fund would need to be comparable. Using 15% of recent annual state spending on higher education as an estimate, covering a possible recession gap in higher education funding in all 50 states would require that the funds collectively accumulate at least $14 billion.

Would these funds be filled immediately or over time?

The money for these state rainy day funds would be invested over time. Drawing out the timeline for this investment too far, however, would mean a high likelihood of a recession happening before the funds were large enough to compensate. Economic forecasting is imprecise, of course—no one knows at any given time when the next recession might occur—but BPC has been working with a timeline of roughly five years to fill the rainy day funds.

How much money would the federal government and states invest?

It is important that the new federal investment be substantial enough to incentivize increased state spending. Further, the amount of federal funding available must be large enough to plausibly fill $14 billion in rainy day funds over a reasonable timeline. One approach would be to provide $4 in federal block grant funding per new dollar of state investment in higher education affordability. This $4 could, in turn, be split between immediate spending on college affordability and filling rainy day funds. If split 50/50 between those two purposes, an investment of $6 billion annually in federal dollars would fill most of the rainy day funds in five years or less (assuming all new state spending is directed to immediate affordability improvements and not the rainy day funds). Once a rainy day fund is full, federal funding could be directed entirely to immediate college affordability, at least until a recession tapped into the fund.

How much federal money is each state eligible to receive from the federal government?

There are many ways funds could be allocated among states. One simple option would be to provide federal block grants in amounts proportional to a state’s higher education enrollment, but that is affected by many factors. Is tuition at public institutions in the state already affordable? Should enrollment in private institutions be included or only in public institutions? Should states with stronger investment in higher education be eligible to receive more funding? Should states where household incomes are lower receive more aid?

BPC has previously proposed using a formula based on several factors, including state investment in higher education affordability and state income level (with a boost in funding for states with lower average incomes). Varying funding would mean that the length of time to fill the rainy day fund would also vary from state to state. Depending on the exact definitions used, this formula, too, could help incentivize effective state spending on college affordability, with states that invest at higher levels and more efficiently being eligible to receive larger federal grants.

What else could be done with this new funding?

As noted above, states could bring down the price of college in several ways, including by supplementing existing policies and programs. This funding might bring the cost of tuition down to zero for some students or pay a higher proportion of living expenses for students who already receive other aid. A primary goal would be to reduce or eliminate the need for students—especially low- and middle-income students—to rely on loans to finance their higher education. In combination with stabilizing state spending on higher education during recessions, a federal college affordability block grant program would be a substantial investment in making college more accessible to students, in the long run, reducing the unpredictable risk posed by student loans to both students and the federal budget.