02/18/92

CONTACT: Stanford University News Service (650) 723-2558

Budget deficit may grow, but magnitude remains uncertain

STANFORD -- Despite apparent success in identifying ways to close a $43 million budget gap, the university still faces a deficit of undefined proportions, President Donald Kennedy told the Faculty Senate Thursday, Feb. 13.

There are no plans to solve the problem through additional academic program cuts, Kennedy said. University trustees, who earlier approved use of reserves to cover deficits projected at that time, now are launching a study of how "they might redeploy university assets to meet possible deficits," he said.

Changes in any of nine variables could "throw off budget projections by millions of dollars in either direction," Kennedy told the senate. Among the variables are indirect cost rates, compliance costs, research volume and interest rates.

Kennedy said the university might experience "substantial short-term negatives," especially in the area of compliance costs, "where we have little control and where the costs are likely to be heavy." This could increase the previously projected deficit for the next two years and jeopardize Stanford's ability to achieve equilibrium thereafter.

"The magnitudes are at this point so uncertain that it's quite impossible to put numbers on them," he said.

Kennedy presented the university's long-range financial forecast, which he emphasized was a "work in progress," on behalf of Provost James N. Rosse, who was in Southern California on business relating to his new position with Freedom Newspapers, Inc.

The Board of Trustees heard reports on the continuing financial problems at its Feb. 10-11 meeting, and does not support further academic program cuts to meet the new deficits, Kennedy said.

"The board understands very well that the success of the budget-reduction effort has left us thin," he said.

In March, university officials will report back to a special meeting of the board's budget committee and will make another report to the senate, Kennedy said.

Meanwhile, a new trustee Task Force on Financial Policies will spend about six months looking at endowment payout rates, treatment of returns on real estate assets, whether Development Office costs should be charged outside the operating budget and a variety of other issues.

These are options "you urged us to consider in meeting the $43 million target," Kennedy told the faculty. The ideas were worthy, Kennedy said, but he is now glad they were held in reserve for what has turned out to be a remaining problem.

The trustee task force will work closely with an internal group that Kennedy said he would appoint soon.

Kennedy said the trustees had "deep admiration for the role the faculty has played in the budget-reduction process." An ad hoc budget committee of local trustees has monitored the process through Saturday morning meetings with faculty and administrators.

Kennedy said he was not pessimistic about the deficits, "nor do I lack faith that we will be able to take care of them in ways that do not place further burdens on our academic programs. At the same time, I have to say that there are a lot of factors bouncing around out there."

Those unpredictable factors include:

• Indirect cost recovery. Kennedy said that officials are negotiating to improve the government-imposed 55.5 percent rate, but that planners cannot assume that rate will rise for 1992- 93. He said he was more optimistic than others that the rate would go up by 1993-94.
• Research volume. Research volume is higher than expected this year. Continued increases would help, he said.
• Interest rates. These are at historic lows, Kennedy said, and negatively affect income from the university's working capital, or expendable funds pool. Earnings from the pool are tied to short-term interest rates.
• Tuition remission. This is the practice of charging part of tuition of graduate students working on research projects to the staff benefits pool as overhead. If the Office of Management and Budget forces Stanford to abandon the practice, graduate students could be included as a direct cost on research grants or subsidized in some other way.

If the policy is changed, the university wants a long transition. Kennedy said that grants are planned for multiple years, and changing those budgets mid-stream "is extremely difficult."

This raises the issue of whether the university should use general funds to cover shortfalls if funding agencies refuse to make good on direct charges submitted by principal investigators, Kennedy said.

University officials are developing contingency plans, but the uncertainty is "very great," Kennedy said. He recently made the university's case in personal visits to officials at the Office of Management and Budget and the Office of the President's Science Adviser.

• Staff benefits. The Defense Contract Audit Agency last September challenged Stanford's proposed 1992 staff benefits rate of 29.4 percent, saying it should be only 19.8 percent. The audit agency challenged tuition remission, faculty sabbaticals, the housing allowance program, the faculty residential area and other small items.
• FASB #106. A recent Federal Accounting Standards Board regulation -- number 106 -- requires businesses and other institutions that offer retiree medical benefits to set aside funds to cover future liabilities. The university has some choice about timing, but the regulation is another example of "the playing field not being exactly level" -- public universities, backed by the taxpayer, do not have to fulfill the accounting obligation, Kennedy said
• Other compliance costs. It is hard to fully predict the one-time costs for legal and accounting support in the indirect cost controversy. Recurring costs include new systems and personnel to handle improved accounting standards, Kennedy said.
• Decapitalization. Using reserves to offset current deficits reduces the amount of interest they will earn for the operating budget in the future.
• Retrospective liability. How much might Stanford owe the government for research overhead collected in the 1980s? University officials believe strongly in the validity of the memoranda of understanding, but Kennedy said the variable cannot be dismissed until the disagreement goes for judicial review.

A report by the Defense Contract Audit Agency saying Stanford may owe the government $231 million for 1981-88 assumes retroactive cancellation of the agreements. Kennedy reminded the senate that only the Office of Naval Research can invalidate the signed agreements. While it canceled existing agreements in 1991, it has not done so retroactively. The university has appealed the 1991 cancellation to the Armed Services Board of Contract Appeals.

Long-range assumptions

Explaining that the numbers are "very, very uncertain," Kennedy presented the current long-range forecast estimates for 1992-93 and 1993-94. The chart shows 7.5 percent tuition and room and board hikes in both years, but Kennedy said officials expected a lower figure for the second year.

Salary merit increases are shown at 4 percent and 4.5 percent, respectively, but those also are placeholders because "we haven't gotten to salary determination yet. We put what seem like reasonable numbers there," he said.

The staff benefit rate is pegged at 34 percent for 1992- 93 and 35.8 percent for 1993-94. The figures take into account, the recently announced staff early retirement program and the need to set aside funds for retiree medical benefits. However, the numbers could drop approximately 4 percentage points if the government eliminates tuition remission for graduate student research assistants. While that would help the benefits rate, it would have serious budget consequences elsewhere, Kennedy said.

The estimated deficit for 1992-93 would be $40.8 million, but when planned deficit reductions are taken into account the number drops to $14.7 million. More than $5 million of the drop is attributed to the large tuition increase and the fact that many units are speeding up rather than delaying implementation of budget reductions.

For 1993-94, the estimated deficit would be $45.4 million, but that drops to just $1.7 million as the current round of budget cutting takes full effect.

However, changes in any of the nine variables listed above could throw off the projections for better or worse.

Kennedy said that tying down the numbers is difficult "not only because of the range of uncertainty but because of the volatility of the political processes that are involved in resolving at least five of the nine issues on this list."

Faculty discussion

During discussion following Kennedy's presentation, art Prof. Al Elsen asked if it was true that next year's deficit had been miscalculated by 50 percent.

The original calculation was based on the best information available at the time, Kennedy said, but variables are dynamic. "A couple of other factors might arise suddenly and unexpectedly to change it, but I would think 50 percent is high," Kennedy said.

Mathematics Prof. Brad Osgood drew laughs in an otherwise sober discussion when he said that all the schools are making cuts except the "Department of Compliance." Will Arthur Andersen, and Coopers and Lybrand be named to tenured positions, he asked. And if, in the end, the memoranda of understanding are validated, "are we going to continue to rob Peter to pay Paul Biddle?"

Kennedy briefly picked up the tone: "I don't think this place ever tenured an accountant outside the Graduate School of Business."

He also said that officials are being vigilant to make sure that cuts are not deeper than necessary.

However, the university is facing an "evolving standard." When the indirect cost problem is over, the institution may face accounting rules that make it more closely resemble a for-profit federal contractor operating under procurement rules than "a university that supplies research and has always thought it was operating under a partnership mode."

Prof. Arthur Bienenstock, materials science and Stanford Synchrotron Radiation Laboratory, said that the faculty had helped the institution face an emergency. He wondered, however, if the process now could be streamlined so faculty could go back to teaching and research.

The process has worn out some professors, Kennedy acknowledged.

"Many of you have been painfully separated from creative activities you love and students who matter to you," he said.

On the other hand, one outcome of the process is that "you are the most knowledgeable faculty in the United States about a family of terribly important issues." Now the university needs to build on that as it reshapes itself to live within new budget constraints, he said.

In that task, "we need the sophistication, the depth of understanding, the knowledge and above all the wonderful community spirit that has been developed in this process," he said.

Kennedy said he didn't want all this "to leak away. It's too precious." However, officials will try to find ways to provide relief, such as rotating the intensity of obligation.

He said that in his last six months as president, "I really have deep hope that we can put the worst part of this trouble behind us and use the knowledge we gained so painfully to accomplish something terrific."

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