Fourth Report of the Tertiary Education Advisory Commission - full report 20/58

Shaping the Funding Framework
Fourth Report
of the Tertiary Education Advisory Commission

Chapter 6: Funding Categories and a Single Funding Formula
(Cont...)

6.3 The Need for a Review of the Cost and
Funding Categories

The Commission's SFF will work most effectively if there is a close fit
between the cost categories and the formula's funding categories. In the first
section of this chapter, the Commission argued that this was no longer so: the
tertiary education system displays extensive cross-subsidisation by providers
and distortionary behaviour on the part of both providers and learners. For
these reasons, the Commission recommends that a systematic review be undertaken
to set cost and funding categories for the new funding arrangements.

Implementing a review of this nature for the entire tertiary education system
will be a formidable and expensive process. Fundamental questions that need to
be addressed before commencing such a review include:

• Which costs should be reflected in the methodology? Should the model be
  based upon actual or desired costs?
• Should the level and type of disaggregation be used as a basis for funding
  (for example, disaggregation at a unit or course level and by type of provider)?
• Should the system have many funding categories or few?
• To what extent should a cost-based system reflect different methods and
  modes of delivery in the funding categories?
• How should overheads and costs jointly associated with non-tuition and
  tuition-related activities such as research be treated?
• Should the funding categories or framework deliver different subsidy levels
  to different types of education or learners, in order to reflect higher or lower
  levels of public benefit?

Frequent adjustment of the funding categories would promote instability and
thus work against the Commission's desire for strategic decision making in the
tertiary education system. On the other hand, there is a clear need for these
categories to reflect social and economic changes.

The Commission considers that the review should be undertaken as a matter of
priority so that the new funding categories can take effect in the 2004 academic
year. Also, the Commission suggests that further cost and funding category
reviews be undertaken about every ten years.

Recommendation 21

The Commission recommends that the government initiate, as a matter of
priority, a systematic review of the cost and funding categories used to
allocate funds within the tertiary education system, including foundation
education (Training Opportunities and Youth Training) and Industry Training
programmes.

Recommendation 22

The Commission recommends that the cost and funding category review be
completed in order that the implementation of the new funding categories can
commence in the 2004 academic year.

6.3.1 The Number of Cost and Funding
Categories

A key design question is how many cost and funding categories there should be
and what funding variations should exist between them.

Having a large number of cost and funding categories would allow for a more
precise match between tuition subsidies and the costs of delivering a course -
and so could provide greater transparency and reduce the incentives for
cross-subsidisation. The existence of many categories would also recognise the
diversity of courses and activities delivered by the tertiary education system.
It would, however, add complexity. In addition, 'game-playing' at the margins to
argue the case for shifts between categories could become easier - even though
financial incentives to do so would be weak (because the shifts are relatively
small).

A funding mechanism with fewer cost and funding categories would be simpler
to administer and understand, but would be less transparent and would give
stronger incentives for cross-subsidisation and course reclassification.
Moreover, having a small number of cost and funding categories while integrating
the Skill NZ sectors into an EFTS-type funding mechanism runs the risk of being
caught between underfunding and delivering windfall gains to some providers in
the tertiary education system.

The Commission concludes that, given the diversity of courses and activities
within the tertiary education system, a new funding framework should err on the
side of matching cost and funding categories as closely as possible to the costs
of delivery within a bulk-funded system. This emphasis would lead to more
categories than at present.

Minority View

One Commissioner favours the view that a funding system driven by student
demand and choice should closely align student fees with the total cost of
delivering a programme. This Commissioner believes that providers will
increasingly reject cross-subsidisation and instead diminish the quality and
quantity of lowmargin courses. The Commissioner therefore favours developing a
larger number of funding categories to underpin the delivery of tuition
subsidies and so ensure there is a close relationship between the tuition
subsidy and the cost of programmes. It is argued that this approach, when taken
in conjunction with the retention of provider autonomy in fee setting, will be
the most effective way of achieving differentiation and appropriate quality.

Staff salaries constitute approximately 70 percent of providers' costs. The
Commission considers that, as a matter of urgency, a review of academic staff
salaries and conditions should be undertaken as part of the cost and funding
category review. This is to reflect the importance of staff within the tertiary
education system and the desire to establish New Zealand as a high-quality
knowledge society. Such reviews of academic salaries and conditions are
relatively common internationally.

Considerable debate surrounds the extent to which academic salaries and
working conditions are affecting staff recruitment and retention in New Zealand.
The Commission, however, considers that the issue of academic salaries and
conditions is so important that it must be a prominent part of the proposed cost
and funding category review.

Recommendation 23

The Commission recommends that, as a significant part of the review of cost
and funding categories, a review of staff salaries and conditions in the
tertiary education system be conducted.

Recommendation 24

The Commission recommends that once a new set of cost categories have been
determined, the government establish what proportion of costs in each category
it is willing to fund through a set of funding categories using the Education
Subsidy Index.

6.3.2 Related Issues for the Cost and Funding Category
Review

The cost and funding category review would obviously need to take into
account changes to the funding of research and research training as recommended
in Chapters 10 and 11. The Commission recommends that a Performance-Based
Research Fund (PBRF) be established and that all existing research
top-ups¹¹² be allocated to it. The
Commission also recommends that post-graduate research training be funded
through a combination of the PBRF and tuition subsidies. The cost of EFTS-funded
research, however, is greater than the sum of the research top-ups. Accordingly,
the proposed review should take into account the re-allocation of funding to the
PBRF.

The initial values for the Education Subsidy Index (ESI) - that is, the
proportion of the total cost that would be subsidised by the government - could
be calculated by estimating the total cost of provision (derived from the
proposed cost and funding category review and current numbers of learners and
trainees) and the total amount of government funding allocated to the various
funding streams. Different values for the ESI would apply to the current
industry training and EFTS systems within the Commission's proposed SFF,
reflecting different proportions of public and private contributions for each.

A strictly cost-based system would reflect cost differentials between
different modes of delivery (such as intramural/extramural,
workplace/provider-based). There are, however, arguments for maintaining funding
neutrality between delivery modes. As an example, the funding differential
between extramural and intramural programmes in the EFTS system was removed in
2000 to promote innovative methods of delivery and to encourage lifelong
learning. Similar arguments could be raised for other parts of the tertiary
education system.

Various 'add-ons' are currently in place to implement decisions made in the
1990s to transfer the funding of clinical training from Vote Health to Vote
Education - the Commission recommends that these 'add-ons' be incorporated into
the appropriate cost and funding categories.

The Commission also proposes that the review consider the costs associated
with the teaching for Te Reo Maori, to reflect the need to protect and enhance
the language.

Recommendation 25

The Commission recommends that the current 'add-ons' for clinical costs
associated with particular courses be reviewed as part of the review of cost and
funding categories.

The Commission further recommends that the review of the cost and funding
categories considers the costs associated with the teaching of Te Reo
Maori.

6.3.3 Possible Approaches to the Cost and Funding
Category Review

The Commission considered a number of specific methodological approaches to
the cost and funding category review, including: a zero-based costing approach;
a least-cost approach; a sample benchmarking approach; and an iterative-bidding
approach. These methodologies are set out in more detail in the working paper
'Options for a Funding Category Review' available on the Commission's
website.¹¹³

The Commission then examined two broad approaches to a review in further
detail: one based on absolute costs; and the other based on relative
costs.¹¹⁴

An approach based on absolute costs would determine the total cost of
providing tertiary education of a given quantity and quality by an estimation of
costs at a course level. An approach based on relative costs would determine the
relative cost, rather than the absolute cost, of different types of courses in
order to inform funding decisions.

Because of the difficulties of defining a desirable level of quality, and
because public expenditure on tertiary education must be prioritised against
other government expenditure, an absolute approach was not preferred for setting
total public funding levels.

A review based on relative costs would be useful because it would allow
public funding to be determined in a way that either did not distort relative
prices, or distorted them in an intentional way. The purpose of a review based
on relative costs would be to ensure that public funding is not causing harmful
distortions towards particular courses and away from other courses. As bulk
funding and cross-subsidisation allow providers to set their own costs, precise
relativities are not essential.

Data collection on the spending by providers at the level of specific courses
would assist the development of a broad profile of relative course costs. These
in turn could be used to assess the extent to which current cost and funding
categories are being overly distorted. Concerns about learner choices and
provider responses therefore suggest that a study of relative costs rather than
absolute costs is more appropriate. A substantial proportion of the review could
be completed simply by investigating the current spending patterns of providers
on different courses.

6.3.4 Australian Experience

The recent Australian experience in costing reviews115 has relevance in this
context, as it provides insight into the potential difficulties involved, and
the importance of process and relationship management. A costing review of
higher education was planned and embarked upon - but there was not sufficient
sector commitment to the process and methodology and, as a result of sector
pressure, the review did not proceed. To ensure that there is not a similar
waste of time and effort in New Zealand, the process must be seen to be fair and
objective (with broad sectoral commitment through an overview group). The
results of a cost and funding category are likely to stand for some time - and,
because the likely outcome of the review will be to redistribute government
funding, the process therefore must have significant rigour in order to be
credible.

6.3.5 Indexation of Cost and Funding
Categories

The Commission has considered whether the new cost and funding categories
should be indexed to adjust them for future price-level changes. There is
currently no provision in tertiary education funding for an annual
price-inflation adjustment to cost and funding categories. By comparison, grants
to Australian universities are adjusted annually to reflect movements in
costs.¹¹⁶

The lack of indexation in existing cost and funding categories has had the
effect, over time, of putting pressure on providers to raise student tuition
fees in order to generate additional fee revenue to compensate for cost changes.
It is argued in Chapter 8, which discusses the predictability of funding, that
cost and funding categories should be indexed annually.

The Commission recommends a unique Tertiary Education Price Index
(TEPI) be established to adjust, annually, benchmark costs established for
tertiary education. The TEPI should be developed in association with the cost
and funding category review. The argument for a TEPI and how it might be applied
are also discussed in Chapter 8.

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Footnote(s):

112

Estimated to be $119 million in 2003.

113

http://www.teac.govt.nz also available from the Commission on request.

114

To some extent, the difference between absolute cost and relative cost
approaches is not as great as it may appear. A relative cost approach is likely
to include the determination of some absolute costs as a basis for estimating
relativities.

115

A further insight, gained from discussions with Australian officials and
sector representatives, suggested that cash injections would be required to
assist implementation of the results of the review. This comment may be
particularly pertinent given the proportion of providers that are not in strong
financial positions.

116

The salary component of institutional operating grants is adjusted in line
with the Australian Industrial Relations Commission's Safety Net Adjustment, and
the non-salary component is adjusted in line with the Commonwealth Treasury's
Measure of Underlying Inflation.