LOOKING INTO THE UC BUDGET -- Report #5a (e-mail version) by Charles Schwartz, Department of Physics, University of California Berkeley, CA 94720. 510-642-4427 April 12, 1993 SUMMARY This Report examines the responses given by the Regents and top UC administrators to the Alternative Budget Plan presented to them at the Board's March 18-19 meeting (see my Report #5.) A detailed study and analysis is given of the objections raised at that meeting by Regent Frank Clark and by President Jack Peltason, along with some other responses. Of particular interest is new data concerning the finances of UC's five teaching hospitals; and it is discovered that substantial amounts put aside for building projects are unrestricted funds that can be re-allocated to more urgent needs. The objections raised by UC's leaders do not survive a reasoned analysis; and the conclusion is that my Alternative Budget Proposals are indeed feasible. Thus, those proposals deserve much further consideration as a means to preserve and protect the University's most precious assets - its faculty and its students. The next round is expected to occur at the Regents meeting in May. ---------------------------------------------------------------------- April 12, 1993 President Jack W. Peltason University of California 300 Lakeside Drive, 22nd Floor Oakland, CA 94612 Dear President Peltason; Here is my latest work, Report #5a in the Series "Looking Into the UC Budget." You will see that the Alternative Budget Plan has gained much strength and credibility as the result of my continuing research, including study of the criticisms which were leveled against it at the March Regents meeting. It is clear that the Regents' vote (12-7) in favor of your Budget Plan was just one step on a long and difficult journey of self- examination for the University of California. You were wise enough to acknowledge that the further development of budget alternatives could lead to a revision of that approved plan; and I believe that my work provides the best immediate possibilities for avoiding the damage that paycuts and increased student fees will inflict upon the University. I hope that you will now begin to treat my proposals in a more constructive manner than you have in the past. When you visited the Berkeley Division of the Academic Senate on April 1, spoke about the University's fiscal crisis and answered faculty members' questions from the floor, I took the opportunity to put my perennial request directly to you. I asked that you, or some expert staff that you might designate, meet in an open forum with me and others to discuss and debate in detail the alternative budget proposals that I have developed. I said that such a public debate would be a win-win proposition: if you should show that I am wrong, then that would increase support among faculty, staff and students for your budget plan, and that would improve campus morale; if, on the other hand, my proposals should be found worthwhile, then that would lead to a better budget plan, benefitting the whole University. Although you said No to my request, the invitation remains open. In any case, I plan to attend the May Regents meeting; and I ask that you provide me the opportunity at that time to engage in substantial discussion with the Board on budget alternatives. In addition, I urge you to ACT IMMEDIATELY to sequester all Unexpended Plant Funds throughout the University. The reason for this request is that these cash accounts contain substantial amounts of "unrestricted" funds (see the data on page 6 of this Report.) Given the fiscal emergency facing the University, I think it is imperative that the Regents have the opportunity to consider re-allocating all or part of those funds to higher priority needs of the University, and this must be done before those moneys are spent on construction projects and the like. Sincerely yours, Charles Schwartz Professor Emeritus cc: Regents' Chair Khachigian -------------------------------------------------------------------- INTRODUCTION Since I entered as a novice into this study of the University's complex finances and budget, it is natural that my reports and proposals would be looked upon with skepticism, especially as they challenge the established expertise and authority of the UC administration. Therefore it is essential that I pay close attention to each objection and criticism raised by the Regents, the President and their staff, studying their responses, going back to the basic sources of data, learning more about the subject, and modifying my own analysis and recommendations as facts or logic may dictate. My previous Reports #2a and #2b (on the question of overgrown administrative bureaucracy) were of this kind, each of them responding to a particular critique delivered from the Office of the President, and each of them leading to a stronger foundation for my continuing work on the budget problem. When the Board of Regents met March 18-19 to adopt a budget for the University's 1993-94 year, they were presented not only with President Peltason's budget plan - featuring further layoffs and fee increases, and a first-ever cut in salary for all faculty and staff - but also with my Alternative Budget Plan (see my Report #5) - featuring instead a substantial trimming of upper level administration, and new revenues to be extracted from UC's teaching hospitals and other peripheral enterprises. No longer able to ignore this challenge, the University's leaders delivered significant responses; and here we shall examine those responses in detail. REGENT CLARK After my allotted 3-minutes to present the Alternative Budget Plan to the Regents' Committee on Finance, Regent Frank W. Clark, Jr., responded as follows to my proposal that the Regents take $105 million, approximately one-half the accumulated Excess Revenues at UC's five teaching hospitals, and apply these funds to alleviate the current budget crisis. [ I have transcribed his remarks from the official tape recording of the Regents meeting, which was provided by the Regents' Secretary.] Regent Clark: "I'd like to make one response to you, Doctor, and that is with regard to - and I think it is incumbent that we let you know right at the outset that we have not hidden, you use the word 'hidden,' any moneys with regard to the hospitals. There are serious, grave legal problems with respect to your suggestion, and I am amazed that you have not considered that in making this statement, and analyzed those problems. We will discuss those more in a few minutes in the Hospital Governance Committee, the General Counsel will. But I want you to know nothing has been hidden, and to make the statement or the allegation that it has been is improper." Regent Clark is a lawyer, the senior partner in a major L. A. law firm, a member of the Board of Regents since 1980, and Chair of the Regents' Committee on Hospital Governance for the past four years. I took his criticisms very seriously, and the following correspondence ensued. ---------------------------------------------------------------------- March 21, 1993 Dear Regent Clark; You raised an issue at the Regents' meeting last Thursday afternoon which needs to be clarified. During the meeting of the Board's Committee on Finance, I was allowed 3-minutes to present my Alternative Budget Plan for 1993-94. You then criticized my proposal that some of the accumulated "Excess of Revenue over Expenses" at UC's five teaching hospitals be taken by the Regents and redirected to alleviate the damage being suffered by the University's core academic program in the current budget crisis. As I heard you, you claimed that there were legal and fiduciary restrictions which made such a consideration impossible; and you chided me for not having looked into these matters. I ask that you enlighten me in detail about these matters. Please tell me precisely what laws, contracts, or other legal obligations stand in the way of my proposal. Sincerely yours, Charles Schwartz ----------------------------------------------------------------------- March 24, 1993 Dear Dr. Schwartz: In response to your letter of March 21, I did not seek to "chide" you, and I apologize in the event that you construed my comment to be anything but constructive. I was seeking by my comment to reaffirm to you and the public, the obligations of the Regents as fiduciaries of the Public Trust constituting the University of California, pursuant to Section 9 of Article IX of the Constitution of the State of California, to prevent any action to be taken by the Regents which would in any manner adversely affect the ability of the Regents to pay the present and future multi- millions of dollars of bonded indebtedness of the hospitals of the University of California. I believe we can agree upon not only the foregoing, but in addition, the present potential impairment of that ability, due to the relatively high costs of operating teaching hospitals resulting from our dedication to medical research and teaching, in addition to patient care, that is resulting from efforts to control, on a national basis, the ever escalating costs of health care generally, and particularly teaching hospitals. Sincerely yours, Frank W. Clark, Jr. ------------------------------------------------------------------------- Given the force of Regent Clark's verbal challenge, I was astonished to see how little substance there was in his letter. The only legal reference he gives is to the California Constitution; and here is what that document has to say about the relevant powers and duties of the Regents: (a) "The University of California shall constitute a public trust, to be administered by the existing corporation known as 'The Regents of the University of California,' with full powers of organization and government, subject only to such legislative control as may be necessary to insure the security of its funds and compliance with the terms of the endowments of the university... (f) "The Regents of the University of California shall be vested with the legal title and the management and disposition of the property of the university and of property held for its benefit and shall have the power to take and to hold, either by purchase or by donation, or gift, testamentary or otherwise, or in any other manner, without restriction, all real and personal property for the benefit of the university or incidentally to its conduct... Said corporation shall also have all the powers necessary or convenient for the effective administration of its trust, including the power to sue and to be sued, to use a seal, and to delegate to its committees or to the faculty of the university, or to others, such authority or functions as it may deem wise. ..." This language gives the Regents enormously broad powers and does not inhibit them from undertaking the action I had proposed. Regent Clark's one specific issue is the ability of the Regents to pay the bonded indebtedness of the UC hospitals. This is a legitimate concern, which required me to gather more detailed data and see exactly what are the amounts of money involved. Using the UC publication, "Hospitals and Clinics Statements, Financial Report, 1990-1991" as well as the five Medical Centers' Annual Reports for 1991-92, I have gathered the following summary data from the "Statement of Changes in Fund Balances" for the last three completed fiscal years. These numbers are for the combined finances of all 5 teaching hospitals (at UCD, UCI, UCLA, UCSD, UCSF.) TABLE 1: Selected Annual Changes in the Balances of the Funds: Equity in Current Assets ($ in Millions) 1989-90 1990-91 1991-92 Excess of Revenues over Expenses (Money Added to the Funds) $ 57.0 $ 58.9 $ 118.1 Appropriations for Plant Improvements (Money Withdrawn from the Funds) $ 66.1 $ 106.2 $ 105.0 Principal Payments on Long-Term Debt (Money Withdrawn from the Funds) $ 8.9 $ 15.6 $ 18.7 Balance at Year End (Includes Depreciation, etc.) $ 135.5 $ 138.3 $ 173.3 The entries in the first row above represent the Net Gain in the hospitals' annual operations; this is the "profit" that first attracted my attention as money that could be used to solve some of the University's budget shortfall. The projected Excess of Revenues for the current fiscal year, 1992-93, is $ 105 million. The entries in the last row of this table represent the Balance of this Equity in Current Assets. As of December 31, 1992, this Balance was $207 million, and this was the number I used in my Alternative Budget Plan - proposing to take half of this accumulated excess, or $105 million, to relieve the University's current budget shortfall. My focusing on this Balance in the Equity in Current Assets fund has been criticized by Vice President Cornelius L. Hopper, who oversees UC's Teaching Hospitals. Here is what he said on this subject at the Regents meeting on March 18: [transcribed from the tape recording] Vice President Hopper: "On the Balance Sheet, I only want to point out, with respect to Equity in Current Assets, there has been some misunderstanding as to what this really represents. And I think the best way of pointing this out is to say that this is the residual ownership that we have in Current Assets. You take the Current Assets, you subtract the Current Liabilities, and then this gives you the Equity in Current Assets. But 77% of those are in Accounts Receivable, they do not represent cash. These reserves are used to reduce the need for borrowing working capital, to fund bottom line losses that are incurred from time to time, and to support both current and future capital projects." I have tried to verify the numbers referred to by Vice President Hopper, taking data from the "UC Teaching Hospitals' Balance Sheet as of December 31, 1992," (See the Report from UCOP to the Regents dated February 8, 1993, Prepared by: Office of the Senior Vice President-- Administration) as follows: ($ in thousands) Total Current Assets....................$ 577,560 Total Current Liabilities...............$ 296,504 Equity in Current Assets.............. $ 207,154 But these numbers do not add up the way Vice President Hopper says. Nevertheless, I now believe that focusing on the Balance of this fund may not be the best way to approach the issue; and I shall instead concentrate on those items that surely represent "real money." The two middle rows of Table 1 contain new and important information about the use of excess operating funds at the hospitals. Entries in row two of the table show the amounts spent on "Expenditures for Plant Assets" plus "Cash Appropriations for Future Plant Improvements." This is a large outlay - $105 million last year - used to expand and improve the hospital facilities; and this is money we now look upon for alternative use in meeting the University's immediate budget crisis. Additional amounts are expected to accrue from current and future Excess Revenues and will likewise be available for re-allocation to higher priority needs of the University. I also note that some of this hospital money, appropriated in the recent past, now resides in "Unexpended Plant Funds" - with a balance of $73 million as of December 31, 1992 - and this money can still be re-allocated at the Regents' discretion to other uses. [For the whole University, over $90 million was transferred from Unrestricted Current Funds to Plant Funds as nonmandatory discretionary allocations during the last fiscal year. See "U. C. Financial Report 1991-1992", page 9.] Row three in Table 1, finally, has the data we need to evaluate Regent Clark's concern: the obligation to repay the hospitals' bonded indebtedness. What stands out is the relatively small magnitude of this item: the Principal Payments amounted to only 16% of the Excess Revenue last year. (Interest payments on the Long-Term Debt come out of operating expenses, so they have already been taken care of before we get to this stage.) Furthermore, this third row in Table 1 includes Principal Payments for all forms of Long-Term Debt at the hospitals, of which bonds constitute only one-half. From this data I conclude that Regent Clark's objection is of only slight significance. The real issue is one of priorities: balancing the needs of the hospitals against the needs of the rest of the University. This balancing is, of course, the central duty of the Regents: and the priorities are determined not by legalistics but by the simple and clear recognition that UC's central academic mission outweighs all other concerns. Again, I emphasize that all of the amounts discussed above are "unrestricted funds", which means that the Regents have full authority to allocate them, or re-allocate them, "for the benefit of the university or incidentally to its conduct," in the words of the State Constitution cited earlier. PRESIDENT PELTASON In addition to Regents Clark's criticisms at the March 18 meeting, President Peltason distributed a white paper, entitled, "A Summary Response to Professor Charles Schwartz's Analysis of the University of California Budget." The full text of that document was attached to my Report #5, and I have appended it again to this Report. The most significant things about President Peltason's white paper are what it does not say. Nowhere does it claim that any fact or figure given in my series of Reports is wrong. Nowhere does it claim that I have misunderstood or misrepresented the budgetary and accounting rules that govern the University's financial planning and fiscal operations. Nowhere does it challenge the validity or internal logic of my analytical work - although at one point (which I shall mention below) it does express a different preference as to methodology. Very significantly, nowhere in his white paper does President Peltason claim that my Alternative Budget Proposals are beyond fiscal possibility or beyond the powers of the Regents to enact. This tacit acceptance of the viability of my Alternative Budget Proposals represents a major retreat from the administration's former position - namely, that President Peltason's budget choices were the only available options. Finally, we come to the test: Are my budget alternatives actually feasible ? In only two instances does the white paper suggest that my proposals may not work; and those, we shall see, are very weak arguments. What, then, is President Peltason's white paper really saying ? It says that the UC administration prefers its budget to mine. The argument - most clearly seen in the case of the hospitals' excess funds - is one of priorities regarding which segments of the University of California need to be protected the most and which can be sacrificed first in this time of overall budget crisis. The most satisfying words in this white paper are found in its last paragraph: "There is, first, a policy issue whether it is appropriate to use fees from these self-supporting programs for general support of UC." This is exactly the policy debate I have been trying to bring out onto the table of public discourse; and this is the policy debate that the administration has been trying to keep locked up behind closed doors. Now, let's turn to the individual arguments of the white paper. The long discussion of "Administration" is barely more than a rehash of the critique presented by Vice President Baker at the February Regents meeting. In my Report #2b, all the issues raised there were thoroughly examined and the details mentioned in Baker's critique were incorporated by me in a revised calculation of the estimated excess in administrative bureaucracy. The white paper does not even acknowledge this improved calculation - the results of which appear in Report #5 in the detailed support for my proposal to cut $80 million from administrative expenditures. The one new critique raised in the white paper has to do with what the accounting category "Academic Administration" covers beyond the nominal definition of "Deans' Offices." There may be some technical issue to be resolved here, but the white paper gives no numbers to indicate whether this is a significant issue or an insignificant one. I have looked carefully through "Campus Financial Schedules 1991-92" for these items mentioned in the white paper; and what I found there leads me to estimate that this is at best a very small correction to my overall estimate of excess administration. There remains a disagreement about which methodology is the right one to use in measuring the growth of administration over many years. I count FTE's and compare their growth over time; President Peltason prefers to look at the fraction of dollars spent on administration, over time. In my Report #2b I gave extensive arguments why I think my methodology is more valid. Obviously, President Peltason is not persuaded. I think that, on theoretical grounds, my argument is much stronger. However, I will assert that neither side in this argument can prove it is correct by mere argumentation. Therefore, how should one choose which side to take ? I answer that the call of prudence and fiscal responsibility is to seek vigorously to remove waste wherever it may be found. Thus, I have called for an immediate cut of $80 million, amounting to one-quarter of my estimated excess in the administration, and also a detailed study of the UC bureaucracy to be conducted by outside management efficiency experts. Throughout this continuing debate over whether and how much the UC administration has grown bureaucratically obese there is one thing that speaks loudly by its absence. (The dog that didn't bark.) If the President were able to say, We had a team of independent efficiency experts scour the whole UC administration just x years ago and they gave us a clean bill of health, that would probably shut me up. My second recommendation was to cut Executive salaries in the University by 25%. President Peltason's response to this proposal is a restatement of the arguments which are all too familiar from last year's debate surrounding the Gardner scandal. My only additional comment, admittedly a subjective one, is that I have not been much impressed, lately, observing the calibre of UC's top executives. President Peltason's response to my third recommendation - taking some of the hospitals' excess revenues - raises no objective obstacles. It is only an argument about UC's internal priorities; and apparently he is more devoted to protecting the hospitals' long term financial affluence than to saving the central academic functions of the University from immediate damage. In response to my last two recommendations - that UC raise revenues by a combination of surcharge and tax upon the operation of its medical clinics and Extension program - President Peltason's white paper offers the suggestion that raising prices might chase customers away and result in reduced income. Here, as in many parts of the white paper, we are given no numbers, no informed estimate of the quantitative significance of the objection raised. I was pleased to note that during the Board's budget debate on March 19, Regent Hall raised these very items and stated his opinion that the 5% and 10% surcharges proposed could indeed succeed. In conclusion, we see that this white paper presents no substantial evidence challenging the feasibility of my Alternative Budget Proposals. What this white paper does show us is a set of budget priorities for the University which put administrators, hospitals and other peripheral enterprises ahead of students and faculty. ------------------------------------------------ "White Paper" issued by UC President Jack W. Peltason, March 18, 1993 A SUMMARY RESPONSE TO PROFESSOR CHARLES SCHWARTZ'S ANALYSIS OF THE UNIVERSITY OF CALIFORNIA BUDGET Administration: Professor Schwartz puts together two budget categories (Institutional Support and Academic Administration) and refers to them jointly as Administration; assumes that Administration represents the upper level of UC management; and asserts that growth in this area has far outpaced growth in Instruction (growth in students and faculty). The fact is, to make a valid comparison, administrative expenditures have grown in proportion to growth in the University. Over the 20-year period 1971-72 through 1991-92, considering expenditures from all fund sources, administrative expenditures declined slightly, dropping from about 12 percent of total expenditures in the early years to about 11 percent in more recent times. Considering just General Fund expenditures (that part of the University's budget which supports core instructional programs), administration has accounted for about 11 percent of total expenditures over the period. Administration at UC includes a wide range of institutional support functions such as accounting, audits, planning and budgeting, contracts and grants administration, computer centers and information systems, payroll and personnel services, purchasing, police, environmental health and safety, facilities management, and a myriad of other support activities in addition to the President and Chancellors, Vice Presidents and Vice Chancellors and the Regents' Officers. Academic Administration, which Professor Schwartz also includes in his definition of Administration, covers not only the deans' immediate offices but also services to students in the area of advising and employment, support for temporary academic staff, and outreach programs to the community. Administration serves the research and public service functions as well as the instructional function. Growth in administration is driven not only by growth in students and faculty, but also by growth in federal and private research funds, teaching hospitals, and state and federal regulations in areas such as environmental health and safety, collective bargaining, affirmative action, handicapped access, and the California Environmental Quality Act (CEQA). UC has received virtually no funding from the State to help address these relatively new and costly administrative requirements. Growth in administration occurs, also, in response to mandated requirements of governmental agencies to provide increased accountability and reporting, stewardship and fiduciary responsibilities such as auditing and institutional debt management, and the need for a multi-campus, single university system to provide the necessary coordination and guidance in an increasingly complex operating environment. Total administrative expenditures include salaries of people who are recharged to self-supporting operations such as UC's teaching hospitals, UC Extension, and auxiliary enterprises such as student housing. Professor Schwartz Recommendation: Cut $80 million or 10% from upper level administration. Response: If "upper level administration" refers to Executive Management (President, Vice Presidents, Chancellors, etc.), a 10% cut would yield about $10 million, not $80 million. To get $80 million from a 10% cut requires an $800 million base. To get such a base, one has to include (1) support services provided by payroll clerks, mail handlers, secretaries, computer programmers, accountants, police, contracts and grants personnel, etc.; and (2) over $400 million in recharges--meaning charges for services provided. If you cut the services provided, then there is norecharge income. As a result of recent budget cuts, campus and Office of the President budgets for administration were cut by 5 percent in 1990-91 and again in 1991-92, for a total cut of 10 percent or $25 million. An additional cut of 10 percent, or nearly $20 million, has been made in 1992-93; further cuts will be made in 1993-94. UC is engaged in a full-scale review of administrative activities in an effort to achieve further management efficiencies throughout the University. Professor Schwartz Recommendation: Cut executive salaries by 25%; yield $10 million. Response: UC must have highly capable executives in order to be well managed and efficient. Competitive salaries are necessary for recruitment and retention of such individuals. Executive salaries have been frozen for three years in a row, even when other employees received merits. Salaries of UC Chancellors lag 14% behind the comparison group this year; the lag will be greater next year when executives and others get a 5% pay cut. Professor Schwartz Recommendation: Take 1/2 of teaching hospitals' accumulated excess ($105 million) and use for general budget purposes. Response: This fails to take the long-term picture into account. UC hospitals have been in great financial difficulty in the past, and will be again in the future given federal and state health care reform efforts. The three former county hospitals treat a disproportionate share of patients supported by public programs such as Medicare and Medi-Cal. In the current year, for example, even with special funds available from SB 855, UC hospitals will be underreimbursed by over $150 million for care of Medi-Cal patients. The cost of patient care is especially high at teaching hospitals which must continuously reinvest gains in state-of-the-art equipment and modernization of facilities in order to remain competitive in a dramatically changing marketplace and at the academic forefront. Based on what other academic medical centers have historically generated, UC believes it needs about a 7% gain for reinvestment purposes, a figure UC has been unable to achieve until recent years and even then at only some of its hospitals. If money for reinvestment is taken from the hospitals now, they will have to be bailed out later on. UC operates the hospitals only for the purpose of supporting teaching, research, and public service programs in the health sciences. Professor Schwartz Recommendation: Add a 5% surcharge to educational sales and services; $25 million. Response: Raising prices will not necessarily generate more income; in fact, income may go down and the teaching program could be harmed. For example, patients in UC dental clinics undergo long waits and tedious examinations in exchange for inexpensive dental care. If the cost goes up, UC could lose patients who are essential to the teaching program. Professor Schwartz Recommendation: Add a 10% surcharge to Extension and Summer Session Fees. Response: There is, first, a policy issue whether it is appropriate to use fees from these self-supporting programs for general support of UC. Secondly, it is not clear that raising fees would necessarily generate more income; instead, fewer students might enroll and income might go down.