I. Introduction.

Many faculty have asked at various times about "the budget process" at the university, with several things in mind. First, from a Faculty Senate perspective (and often, from the perspective of various school-level faculty organizations such as the Faculty Council of the College or the Medical Faculty Council) there is a question about how the faculty can get more involved in the budgeting process. The second issue relates to priority setting for large capital projects -- where does the money come from, what determines which projects are approved and which are deferred, etc. The third issue relates to a more diffuse question -- "isn't there some money around to support X?" where X can be a wide variety of activities (new projects, interim research funding, ....) These discussions have come up with sufficient frequency that the Executive Committee of the Faculty Senate asked if I would speak about the general budgeting process to the Senate, and -- through the minutes of the Senate -- to the faculty generally. These comments come in response to that request.

II. General Budget Issues

The budgets of the University come in three generic flavors, which add up to the aggregate budget. (Here, I will set aside two specific budgets within the Medical Center that are quite different -- those of Strong Memorial Hospital, a self-contained budget entity, and of the Medical Faculty Group, the enterprise through which professional fees from medical practice flow.) The three generic flavors of budget are (a) "division" operating budgets, (b) capital budgets, and (c) central administration operating budgets.

Let me begin with the divisional operating budgets. Each of these budgets has inflows (revenues) and outflows (expenses). We seek a balancing of the inflows and outflows for each division within the University as a general operating rule, sometimes called the rule of "every tub on its own bottom."

Let us begin with the general idea of inflows -- revenues and transfers that add resources to a division's budget. These consist in general of the following categories (with very different proportions from division to division):

o Tuition Revenues

o Research grants and contracts (NIH, NSF, other government, foundation, etc.)

o Gifts (annual giving, corporate gifts, etc.)

o Endowment earnings

Except for the odd occasion, every activity within the University must be supported by revenues coming from sources like these.

Divisions within the University (Schools, the LLE, etc.) also have various types of expenses, some relatively fixed in nature, others more flexible. These include (generically, and again, with very different mixes from division to division):

o Faculty salaries and benefits

-- full time (tenure track and tenure, indefinite term, short-term visitor)

o Staff salaries and benefits

o Graduate student stipends

o Amortization of capital (buildings, renovations, equipment, etc.)

o Equipment and supplies (computers, paper, pens, laboratory supplies, etc.)

o Allocated costs from Central Administration (more about this in a moment)

o Travel

o Libraries and facilities

Much of this cost structure is fixed, or nearly so, in the short run. Education is a very labor-intensive industry, and about three quarters of the costs of the University are salaries and wages to faculty and staff. These are difficult to change in the short run, all the more so with tenure commitments to faculty. Also "fixed" and irrevocable are costs paid for previous capital decisions (buildings, renovations, equipment, etc.) Other costs are more variable in the short run, including such things as "visitor" salaries, travel, and the like. The most variable of all are discretionary spending projects (one time events, often) that create much of the joie de vivre of universities, but which necessarily fall by the wayside in the face of budget problems.

When any division is confronted with an imbalance between revenue and costs, several choices allow short run "fixes" and others improve things in the long run. On the cost side, short run fixes (not necessarily desirable, but things we have seen employed at this and other universities) include hiring freezes, salary freezes, elimination of maintenance on the capital plant ("deferred maintenance"), and increased use of the endowment. In the long run, almost all of these "solutions" exacerbate the problem, rather than helping it, since they harm program (hiring freezes), reduce the competitiveness of our compensation (and in the long run, faculty and staff quality), build up a backlog of deferred maintenance (which ultimately costs more in the long run to fix than proper maintenance would have cost), or reduce the amount of endowment available for future programs. In other words, these short-run solutions usually rob from the future to fix the present.

On the revenue side, other "fixes" are available, both short and long run. In the short run, a common solution -- used here in the past, and widely used across American higher education in recent years -- is to expand student enrollment to gain more tuition revenue. We did this in the College over a 20 year period, adding 1000 undergraduates (about 20% increase), and we have done it in the Eastman School over the past decade as well (also about a 20% increase). This cannot be a permanent solution: student body quality falls with each increase in size, reducing the attraction of the school to desirable students. Ultimately, one also confronts limitations on the capital plant (housing, classroom, labs, dining, recreation facilities) that either limit the use of this approach, or require new expenditures (new dorms, etc.) to support the student body.

In the long run, one must make the schools of the University sufficiently high quality to attract both high quality, high pay students (the key issue with the College) and to attract external research support (a key issue in the School of Medicine and Dentistry and the School of Nursing now), both for the financial consequences and the reputational consequences.

III. The Budget Process

Given this preface, we can now turn to the actual budget process of the University. We begin with certain parameters determined globally for the University by the President and key staff, the most important of which parameters are also approved by the Board of Trustees. These basic parameters of the budget process include (a) the rate of draw on the University's endowment resources. (b) The wage and salary program, including both staff and faculty salaries. In recent years, President Jackson and I have approved a range of salary increases for the University, with different divisions allowed to adopt values within that range as their own financial circumstances permit and suggest. (c) Tuition and room and board charges. Again, we allow differential increases across schools, depending on their own circumstances. (d) The University's benefit rate is determined by previous agreements on the scope of benefits; annual estimates are made of the costs of providing these benefits, which become "benefit rate" numbers that are attached to all wages and salaries within the University as part of the budget. (d) Allocated costs from Central Administration are set forth. (more about these below.)

Within these parameters, the key financial decisions all arise out of the recommendations of Deans and Directors of the various operating divisions. Deans and Directors (and their corresponding financial officers) assemble information that helps predict both the revenues and the costs for the coming year, and these flow into the overall budget. In this sense, budgets are both predictions and targets. We seek, of course, to have these predictions come through with a high degree of accuracy, but sometimes unforeseeable events add or subtract to the bottom line predicted by those budgets. Typically, elements in the budget forecast have the same types of categories as the revenue and expense items listed above: predicted numbers of students returning (and new enrollees), predicted sponsored research support, predicted gift income, etc. Similarly, known additions and departures from the faculty and staff are factored in, which (when combined with decisions on wages and salaries) lead to estimates of total expenditures on the people working within each division.

The next step looks at proposed capital additions and their costs. These include building renovations, modifications of lab space for new faculty, and (occasionally) new building additions. These types of costs are borne directly by the division benefiting from the new construction. Thus, for example, the costs of the addition of Schlegel Hall were built into the budgets of the Simon School, and the modifications in Dewey Hall that accompanied that process were charged to the Simon School and the Warner School, since those divisions are the users (and in some sense, the "owners") of those buildings. New capital additions provide one of the areas of budget flexibility; when times are tight, we can cut back on new capital additions, and when the future looks stronger, more capital additions and improvements are possible.

Finally, discretionary costs enter the picture. These typically include one-time projects, augmentations of the wage and salary program of the division beyond the "base" proposed package, etc.

At the point where the various Deans and Directors have assembled their proposed budget, we then have a series of meetings between those Deans and Directors and the central administration. The deans and directors bring with them their financial officers (who have helped assemble the pertinent financial information and budgets). These meetings typically involve the Provost (as the chief academic officer of the University) and the Vice President for Budgets and Planning; sometimes other central administration staff are brought along as needed.

At this point, the dialog (to borrow a phrase from the US Senate's role in the US President's selection of key administration officials) focuses on my role as Provost -- "to advise and consent" to the proposed budget of each Division. If the proposed budget (from our view) includes all relevant costs, includes realistic forecasts of revenues, and balances revenues and costs, these meetings can be relatively short and sweet. We "consent" to the proposed budgets, and those then enter into Vice President Paprocki's University budget.

If the budget is out of balance unfavorably (the much more common occurrence than one favorably out of balance, for obvious reasons) then the "advise" process becomes more important. We work out ways to bring the budget into balance, working until we achieve agreement. Sometimes that agreement involves changing the assumptions (e.g., the Division may have been overly pessimistic about revenues or costs, and we agree on a more optimistic forecast). Sometimes we necessarily talk about changes in program, or deferral of capital improvements, or other changes in the cost structure of the division where there is real flexibility. Sometimes (unhappily) we reach the conclusion that there is no way to achieve the balance we seek, at which point we have to decide if we are willing to take a budget to the Board of Trustees that is out of balance (which implies, ultimately, that they approve a higher endowment spending than originally intended).

This last point is central and essential to the process. The university's endowments (plural) ultimately are the payer of last resort in the budget process. If we overspend our revenue capabilities, the endowment falls. If we underspend our revenue capabilities, the endowment rises. Ultimately, we ourselves bear the consequences of these decisions in the future. A higher endowment spending rate this year makes for a smaller endowment than would otherwise be the case for all future years in the history of the university, unless the excess spending improves the university's financial position in some way (attracting more revenue through student tuition or research grants) or reduces future costs in some way (e.g., by automating some function that allows a reduction in staff costs in the future).

I stated that the university has endowments (plural) because that is precisely the case. Through the stated intentions of donors, much of the University's endowment (and this is true in all universities) is restricted in use. The most prominent of such restrictions are those imposed by the original gifts of George Eastman to found the School of Medicine and Dentistry and the Eastman School of Music. By law, we cannot divert the earnings from those gifts to other parts of the university. Similarly, there are other important restricted gifts to other divisions of the University. In recent times, the naming gifts of William E. Simon (for the Simon School), William Scandling (for the Warner School of Graduate Education and Human Development), and the most recent large gift of Robert and Pamela Goergen to The College are examples of gifts that are restricted "geographically." In addition, many divisions of the university have gifts that are still further restricted, e.g., to the support of a particular named professorship, or for certain programs.

The remaining unrestricted endowment of the University is the final bearer of financial burden or windfall. In the divisions with separate endowments (ESM and SMD), their own "geographically restricted" but otherwise unrestricted endowments serve the same purpose. (In more classic business terms, the unrestricted endowment is as close as a University has to the "residual claimant," the owner of a firm through direct ownership, partnership participation, ownership of common stock. These owners receive all of the profits and bear all of the losses of the typical business enterprise.)

One of the major functions of the central administration in the preparation and approval of budgets of the operating divisions (and hence the overall University budget) is to act as the careful custodian and guardian of the unrestricted and restricted endowments of the University. These endowments link together the present and the future.

IV. Capital Budgets

Capital investments really come in two flavors -- renewal and replacement of existing capital (things like replacing roofs, painting, window caulking, heating and cooling systems, etc.) and additions of genuinely new capital (new buildings, new major equipment). Between these two categories is a major additional type of capital investment-- refurbishing of existing space for new uses. The additions of the Ambulatory Care Facility in the Medical Center, the Eastman Living Center on the Eastman campus, and the Carol Simon Hall and the Computer Studies Building on the River Campus are good examples of recent new major capital additions. Almost every campus has seen frequent examples of the intermediate category -- refurbishing space for new uses. Recent examples of major capital expenditure of the "renewal and replacement" variety include the dormitory renovation program on the River Campus over the past few years, and the major capital investment in the Eastman School main building for such things as roofs, plumbing, carpets, etc. that will have little visible consequence when completed.

Generally in the decentralized budget process of the university, initiatives for new capital spending come from the divisions. (Central decision making gets involved in some decisions that affect wide parts of the campus, such as computing network decisions, administrative computing, general classroom space used by more than one school, library investments, and the like). Project proposals flow up from individual faculty and departments to deans, and these proposals flow to the general capital budget process. Each project comes with a cost-benefit analysis (sometimes "hard", sometimes "soft", particularly on the "benefit" side of things) expressing why it is a good idea. The evaluation of these projects generally takes place within the divisions which the project will benefit, but there is also an over-riding University level concern about aggregate capital borrowing.

The costs of capital projects can be met in a variety of ways. In some cases, we have direct gifts to support the project. As a general rule, this university will not engage in a capital project on the basis of a gift unless the gift wholly covers the costs of the project. (In a complete sense, such a gift should also include a sufficiently large endowment to cover the operation and maintenance of the building, unless the activities within the building will generate enough new revenues to cover the O&M costs.) We make exceptions to this, of course, depending on the nature of the building and the overall university benefit brought by the capital project and the availability of other sources of funds to complete the project.

Other sources of funds can come from several generic sources. First, if the building encompasses sponsored research (NIH, NSF, DOE, and the like) then we can expect to recoup much, if not all of the costs of the building through research grants and contracts, so long as the building's function continues to be the support of sponsored research. The other obvious source of revenue to support a new capital project is new tuition revenue, e.g., if the project allows or supports a new program expansion that brings in sufficient new tuition revenue to pay for the project.

We do not normally pay for capital projects in a single year, but rather amortize them across the expected useful life span of the building, equipment, or whatever. One can think about this as something akin to a mortgage payment, where the annual payment covers both ongoing interest charges and sufficient repayment of capital so that (by the end of the amortization period), the capital costs are fully repaid. This approach holds true whether the source of funds is internal (use of endowment) or external (bonds, loans, etc.).

When we contemplate any new capital project, whenever the resources to pay for it are not completely in hand, we analyze the ability of the division seeking the capital project to bear the "mortgage" costs into the future. The ability of a division to cover this year's portion of the costs is not sufficient to allow us to enter into a major capital project; we also must be assured (as best possible) that the division will have sufficient revenue to cover these new capital repayment costs in addition to other costs necessary to carry out the activities of the division. The annual "mortgage" payments for each capital project enter the overall cost stream of the division, and become part of the overall revenue vs. costs comparison discussed earlier. The only distinction made for capital costs, in some sense, is that capital investments require that we have a multi-year picture in hand about the future revenues and costs, so that we can be comfortable of our ability to cover the new capital expenditures as well as other ongoing operational costs.

Capital investments can include more ephemeral projects than buildings. They can include, for example, computer software for management systems, or even the decision to invest in a new promotional activity for the University. Arguments are often made (and sometimes accepted) that the addition of new staff in areas such as development, public relations, etc. or new advertising to attract new students (enrollment enhancement) are really "investment" in the future. While in concept these ideas can be correct, we generally hold to the notion that the investment of resources now in anticipation of future payoff (in terms of more donations, more students, etc.) requires careful consideration, because it is often difficult, if not impossible to establish the link between the "investment" and any subsequent payoff.[1]

After each division considers potential capital projects and evaluates their ability to pay for them, we have another "central" step that we need to consider -- the effect of the new project on our aggregate university borrowing position. There are two important aspects of these decisions that must be considered. First, we have (by state law) the ability to borrow up to $150 million through tax-exempt mechanisms (usually by issuing tax-exempt bonds through something like the NY State Dormitory Authority). We must always be aware of our position relative to this cap, because if we exceed it, the cost of borrowing changes for the entire university. Second, the business (banking) community continually evaluates colleges and universities just as they do other businesses, issuing credit ratings that affect the rates at which we can borrow in general (with or without the tax exemption). Our overall credit worthiness as a university (not the component parts) can have a considerable effect on our overall costs of business. Thus, we continually evaluate the consequences of new projects on various financial indicators of relevance to the external banking and finance worlds, making sure that we are not moving into ranges of borrowing that would cause them to reduce our credit rankings. (There are, of course, occasions when one would want to borrow even if it did reduce the credit ratings, but we must continually keep track of such issues.)

V. Allocated Costs

One of the great mysteries of university life to most faculty in this (or any) university is the system of "allocated costs." Some parts of the University do not have their own revenue sources, but are nevertheless essential for the ongoing operation of the University (or at least we will allege so for the moment!). University officials (President, Provost, Vice President) and their staffs of course are part of this. Of much greater magnitude are the costs of maintaining the physical plant, so-called operation and maintenance (O&M) costs, including such things as electricity, coal for the steam plant, and the myriad people necessary to keep the physical plant functioning. These functions serve everybody in the University. Other "central" functions serve some divisions more than others, including admissions, public relations, sports and recreation, and so forth. The University provides some functions at a charge, and we generally try to set the fees for such activities so that the charges recover their own costs. Parking represents the most prominent of these functions. To the extent that we can recover the costs of operation by directly charging users of the system, the costs of those functions do not enter the allocated cost pool.

These costs are allocated to divisions of the university -- and thus become part of their operating budgets that must be met by their own revenue streams -- by methods chosen to resemble as closely as we can determine the distribution of services performed. Thus, for example, housekeeping services are allocated on a square foot basis, and divisions pay for those costs based on the square footage of space allocated to them. Student-related services (such as admissions and financial aid) are allocated on a per-student basis to the schools using those central services. Payroll and benefits office costs are allocated on a per-employee basis. These few examples are only intended to suggest the sorts of mechanisms through with costs are allocated when University functions do not have direct revenue streams available to cover their costs.

As a related point (added to the first point, namely that the Central Administration does not have its own source of revenue), and given that we maintain as much as possible of the University's operating budgets within the hands of Deans and Directors, the corollary point emerges that the Central Administration (President, Provost, etc.) does not have a big bag of gold stashed away from which there can be free and easy spending. As hard as I have looked, I have yet to find such a bag of gold (or any other currency) hidden under my desk in the Provost's office, or anywhere else in the environs. To make the point as forcefully as I can, if I were to develop such a "bag of gold" to be dispersed through my office, it would necessarily require that those resources be withdrawn from the budgets of the operating divisions (schools) of the University, either through a direct capture of parts of the unrestricted endowment income (the consequences of which would be reduced revenue available, in the very large part, for the College) or through a "tax" on the activities of all divisions of the University (in which case the resources would be withdrawn from all schools' budgets). This is a very simple but important idea: We believe, in general, that the University is better off having those resources immediately in the hands of the schools, rather than in the hands of central administration, because the money will then be available for those closer to the relevant academic and programmatic decisions. I would hope to work forward in future years to a modest "Provost's Fund" for advancing new programs and projects, but then only to focus on activities that spanned across more than one school or division. However, the general rule still applies -- if I had such a source of funds, I would have had to have taken it away from the schools of the University before I could give it back. I would undertake such a role only with clear purpose and clarity that the resource allocation within schools was missing out on an important opportunity.

VI. How Can Faculty Get Involved?

As the foregoing discussion has suggested, the primary development of "the university budget" takes place at levels much lower in the University than Central Administration. Within departments, the key point of interaction is the Chair of the department (or, within the Medical School, often the Division Chief). This is the point where new ideas must enter the system, either requests for new spending or ideas for new revenues. These requests and ideas get carried forward from departments to Deans and Directors in the normal course of budget development during the year, and these, in turn, are assembled by the Dean or Director in overall budget discussions with the Provost and Vice President for Budgets and Finance. Thus, faculty interested in the budget process need to get involved through their departments in the first instance. Most deans and directors rely heavily on their department chairs as the point of interaction on budgets, and rightly so, since those are the individuals responsible both for the formation and management of budgets over time.

Second, it should be obvious that faculty have important direct and indirect effects on revenues. Faculty can and do envision new programs that generate new tuition revenue (e.g., new Masters programs). Faculty are fundamentally essential in generating research support, both through formal mechanisms of sponsored research (NIH, NSF, and the like) and through other less formal sources (industrial, foundations). Faculty can also take a role in generating new gifts and on occasion, major capital contributions. In the long run, it is fundamentally important for faculty to work hard to create a stimulating and enjoyable intellectual and social environment for students, particularly in those divisions where student revenue is a dominant source of income (as is true in almost all academic divisions except the SMD).

Finally, it should be equally obvious that faculty interest in the budget process at the "university" end is misplaced, in the sense that we have relatively little to do with budget formation of individual divisions within the university, except by setting the overall parameters within which the budget is formed (endowment draw rates, wage and salary program parameters, etc.) and through the "advise and consent" process that takes place overall.

[1] You would be surprised how often we are confronted with the argument that an expenditure of resources is desirable because it is an "investment for the future." In concept, such arguments are correct in terms of the direction of the effect, but they seldom carry on to the point of quantifying the magnitude of the future benefits. Any expenditure that enhances program can be considered as an investment in this sense, but that does not necessarily make it a good investment. Good investments will either pay back their costs or add sufficiently to the overall prestige, etc. of the University to make them desirable even if they do not cover their costs over time.