Budget Sense

by Kevin Carmody | 2/4/03 6:00am

Since the administration's announcement that the varsity swimming and diving teams would not be eliminated, the fervor surrounding Dartmouth's budget has subsided. To save face as it changed course, the administration used a loophole in its own rhetoric to back out of its misguided decision to cut the program. It did so by accepting $2 million from generous alumni to fund the teams for the next 10 years, at which point other sources of support will have been identified. This outcome is almost stunning in its simplicity and foresight. Since the College still faces projected budgetary shortfalls in the coming years, the way in which swimming and diving was saved offers the best road map for how to negotiate financial troubles in the near future.

What makes the solution to the swimming and diving crisis so smart is that it recognizes that while we are facing budgetary problems now that demand an influx of ready cash, in 10 years things will be better. During the roaring 90s, the endowment posted enormous investment gains, mostly fueled by the run-up in U.S. equity markets. Over the past several years, the bursting of the stock market bubble has caused large endowments, like Dartmouth's, to post poorer returns. No longer can the administration increase the contribution of the endowment to the annual budget without increasing the percentage of the endowment being spent to that end. Yet the economy will not be in a slump forever. Already, signs of renewed growth are emerging, and in 10 years, barring an economic catastrophe on the scale of the Great Depression, asset values will have risen again. Once the $2 million donated this year has expired, endowment interest will have expanded and funding for swimming and diving can once again be drawn from traditional sources.

Before moving on to how this applies to the entirety of the budget, however, it is important first to provide a brief overview of how Dartmouth College operates as a financial entity. The second largest source of the annual budget is interest from the endowment, which provides approximately a third of total annual revenue. Currently, the endowment is valued at approximately $2.2 billion. The 78 percent of the endowment reserved for the undergraduate college is, however, more than simply a pot of money from which to draw interest. Over half of it, 56 percent, is restricted, meaning the stipulation of the donor was that their gift could only be used on certain things. Partially restricted funds make up 27 percent, and unrestricted funds, of which the administration is naturally most fond, rounds out the last 17 percent. The Trustees have explicit legal authorization not only to direct the interest of these unrestricted and partially restricted funds, but also to spend that capital.

The problem the College faces is not a lack of funds. $2 billion could sustain the school for years to come, even if tuition were eliminated. The problem is that if a fixed percentage (or a percentage in a narrow range) of the endowment is to be spent each year, in tough years, endowment spending will naturally fall. This is a temporary challenge. It was not an issue in 1996, when, for the first time, the value of endowment grew larger than one billion dollars, and it will not be a problem eight years hence. In the meantime, instead of making drastic cuts in the budget, the more farsighted course of action would be to engage in a controlled spending of principal.

In the Dartmouth College Annual Report for 2002, the official financial statement of the College, points out that the $300 million decline in the endowment in the Fiscal Years 2001 and 2002 represent "the first consecutive annual decreases since the 1970s." Our current financial situation, then, is highly unusual. It goes on to point out that as of June 30, 2002, the College had $721 million of unrestricted assets, which are controlled at the complete discretion of the Trustees. In Fiscal Year 2003, the administration determined it needed to cut $1.6 million, a sum that represents .002 percent of total unrestricted assets, and .0007 percent of the total, institution-wide endowment. Instead of cutting an entire varsity sports program, the College could merely spend $1.6 million of its endowment this year to cover the gap.

The endowment lost 5.9 percent of its value in Fiscal Year 2002, and it expects to lose more in Fiscal Year 2003. In fact, not only are $1.6 million in budget cuts scheduled for this year, but Fiscal Year 2004 has $5.4 million in planned cutbacks due to an expected decrease in total endowment worth, and the requisite decrease in interest. This begs the question: for what are we saving? Assuming that the College will have greater resources in 10 years than it has today -- an assumption supported by history -- it makes little sense to transfer resources from the education of today's students to the education of tomorrow's students, especially when the endowment will be worth less next year than it is this year. We would be better off spending now. Henry Hansman, a Professor of Law at Yale, in his article "Why Do Universities Have Endowments," which was published in the Journal of Legal Studies in Jan. 1990, argues that ensuring what he calls "intergenerational equity," that is, making certain that future generations have access to a similar quality of education as do today's students, is a very weak justification for amassing such massive quantities of wealth. Since the United States has enjoyed constant GDP growth when measured over any significant period of time, it makes more sense for tomorrow's wealthier alumni to pay the cost of today's students, even through issuing debt, than for today's poorer students to pay the cost for the future by having an endowment that grows faster than inflation.

From a logical perspective, the best argument for an endowment is to provide a financial cushion in times of budgetary shortfall. But our administration has decided that rather than let the endowment suffer as much as the equity in which it was invested, it will protect the endowment by transferring resources away from students. It is balancing the budget on the backs of today's students and insuring that the endowment does not suffer as it should. If our College is an institution at which pedagogical goals are ascendant, such a policy is unacceptable and wrong. While the Trustees, many of whom have business backgrounds, may see a large endowment as an accomplishment, it cannot be seen as such if it came from skimming off the top of our education.

As a long-term strategy, to be sure, fiscal conservatism ought guide the College's budgetary practices. Our current situation, however, is exceptional. Spending so minute a fraction of it today to ensure that our institution can continue to provide a liberal education without harsh cutbacks makes sense. The administration should consider limited principal expenditures as part of its plan to weather the financial storm.