Building Resilience: The Case for Rainy-Day Funds in Higher Education

As the COVID-19 pandemic unfolded in early 2020, higher education experts warned that public colleges and universities faced the imminent threat of severe budget pressures similar to those of the 2008 recession. Yet, for the most part, these fears did not materialize. As part of its pandemic relief efforts, the federal government distributed nearly $76 billion in emergency funding for higher education, as well as hundreds of billions more to states for general budgetary relief.

These federal relief funds played a pivotal role in preventing severe cuts, stabilizing state higher education spending, and lowering college costs for students. Yet, federal emergency funding fails to deliver a viable long-term solution to recessionary pressures for postsecondary education. Federal emergency funding is costly, potentially inefficient, and provides no guarantee for state institutions of higher education during the next recession. Rainy-day funds, designed to mitigate the impact of unexpected financial shocks, are essential for fostering greater resilience in higher education budgets and long-term financial sustainability in postsecondary education.

The Vulnerability of Higher Education Funding During Recessions

Higher education is highly susceptible to funding shortfalls during recessions, when nearly all states struggle to maintain spending levels as they face reduced revenues and balanced budget requirements. For states looking to trim spending, higher education funding is often first to go for three reasons: 1) it is a discretionary fund, with spending levels determined on an annual basis; 2) it is the third or fourth largest spending category in most states; and 3) institutions can generate external revenue—especially through tuition and student fees—to offset funding cuts. Consequently, some researchers characterize higher education funding as a “balance wheel” for state budgets. In times of economic downturns, states frequently implement more pronounced reductions in higher education spending compared to other budget areas. As a result, a recurrent pattern emerges where state funding decreases while tuition and enrollment rise.

Figure 1 shows how the 2000 and 2008 recessions led to substantial cuts to state higher education appropriations and subsequently to many public institutions leveraging tuition dollars to fill that gap. As a result of the 2000 recession, for example, state educational appropriations declined by 17%, while net tuition revenue per full-time equivalent (FTE) student at public colleges and universities rose by 8%. Subsequently, state educational appropriations saw a more substantial drop of 23% between 2008 and 2012 due to the Great Recession. Net tuition revenue per FTE increased by 18% at public institutions during those years. Institutions that were unable to raise tuition sufficiently to compensate for lost revenues responded by reducing capacity, shrinking or cutting programs, or limiting supportive services for students.

The countercyclical nature of higher education, with enrollment tending to rise in recessions, exacerbates these budgetary challenges. During economic downturns, uncertain job markets and layoffs push students to delay finishing their education and lead working-age adults to return to school. Enrollment during the Great Recession experienced a particularly sharp increase of almost 11%. Consequently, during economic downturns, institutions must often grapple with the challenge of reduced state funding while adapting to a growing student body.

Navigating the Unprecedented

The pandemic marked a departure from previous recessionary trends in higher education. Due in part to pandemic-related disruptions (including health concerns and challenges in transitioning to virtual learning), higher education enrollment declined during the pandemic. At the same time, significant federal relief and an unexpectedly rapid economic rebound allowed states to largely maintain and even expand higher education spending.

During earlier recessions, the federal government provided states with funding to help cushion the impact of falling state revenues. During the Great Recession, for example, federal aid came in the form of the American Recovery and Reinvestment Act (ARRA), which included a State Fiscal Stabilization Fund (SFSF) that provided $49 billion in state grants designated for both K-12 and higher education. While this aid helped alleviate states’ budgetary challenges and mitigate the scale of tuition increases in some states, it was insufficient to offset significant reductions in postsecondary appropriations.

In contrast, the federal government responded to the pandemic with unprecedented emergency aid. The three federal pandemic relief packages—the Coronavirus Aid, Relief, and Economic Security Act (CARES); the Coronavirus Response and Relief Supplemental Appropriations Act (CRRSAA); and the American Rescue Plan (ARP)—allocated a combined $76 billion in federal emergency aid to higher education alone, providing institutions with grants to compensate for lost revenue and defray costs associated with the transition to distance education, as well as to provide additional financial aid to students. Moreover, these legislative packages included more than $300 billion to states in flexible budgetary relief and assistance which helped states avoid turning to the higher education “balance wheel.”

This surge in federal rescue funds, together with a rapid economic recovery that fueled state revenues, contributed to a 10% increase in state higher education appropriations between 2021 and 2022—and helped public colleges and universities avoid the tuition increases seen in previous recessions. During that same period, net tuition revenue per FTE student declined 7% at two-year institutions and stayed flat at four-year institutions. The State Higher Education Executive Officers Association (SHEEO) suggests this was partially due to minimal increases in tuition rates and a rise in state financial aid. Indeed, according to College Board, sticker tuition at public four-year and two-year institutions dropped by 3% between the 2020-2021 and 2021-2022 academic years and then by 5% between 2021-2022 and 2022-2023.

Although emergency aid played a crucial role in sustaining the higher education system during the pandemic recession, it serves as a costly, inefficient Band-Aid and is not a sustainable solution. Additionally, the availability and allocation of this type of emergency federal funding is subject to political processes and priorities. As persistent deficits add pressure to federal budgets, the chances of future aid like that provided in 2020 and 2021 becomes increasingly unlikely. Proactive, long-term strategies are needed to enhance financial stability and resilience in the higher education sector.

The Role of Rainy-Day Funds in Higher Education

Rainy-day funds are a promising solution to the financial challenges that economic downturns pose for higher education. Since the 1980s, every state has established at least one rainy-day fund to help cushion state spending against recessionary shortfalls, with these funds reaching a record national total of $79 billion before the pandemic. Broad rainy-day funds, however, must serve multiple priorities and, as a result, do not guarantee protection for higher education. In contrast, dedicated rainy-day funds would provide a safeguard against recession-induced cuts to postsecondary spending.

BPC’s Task Force on Higher Education Financing and Student Outcomes proposed providing federal matching funds for states that increase higher education spending, with a portion of the match set aside in a rainy-day fund. By reserving a portion of these additional federal dollars for economic downturns, states could stabilize their investment in higher education and give colleges and universities more predictability in their planning and budgeting. This approach aims to break the cycle of disinvestment, alleviate funding shortfalls, avoid expensive federal bailouts, and reduce the necessity for colleges to raise tuition, ultimately lessening reliance on student debt.

Recessions and their impact on state budgets are inevitable. To build a more financially stable higher education system, policymakers must account for these downturns. Implementing a countercyclical mechanism like rainy-day funds can help break the cycle of governing by crisis and ensure that investments in higher education are sustainable in the long run, fostering resilience and stability for institutions and students alike.