Law Schools' Fistful of Dollars
Law schools would like a few dollars more.
“Everything in Between” is about the systems, institutions, and practices that people build, “things” of a sort that sit in between us, between groups of us, between “us” and “them,” and between us and other systems and institutions that seem terribly far away: “the market,” “the state,” the universe, and so on. Once a week, usually on a Monday, I’ll have something new.
This is the next-to-last installment of my essay on the past, present, and future of law schools, partly as interesting, useful, and important institutions in their own rights and partly as case studies for exploring higher education full stop. I started by introducing the theme and a big picture summary: law schools on the whole, like universities on the whole, confront giant structural, systemic challenges that are partly economic, partly cultural, and partly epistemological. Then, I got started with some details. How did we get here? I began with an initial look at the history of US legal education. Next, I hit the proverbial heights, describing the high performing, economically stable law school that thrives in the imaginations of many lawyers, judges, and law professors today. Last week, the edifice crashed against contemporary reality.
What now? I’m interested - for now - mostly in finance. Whatever law school(s) might become, the money has to come from somewhere. The private sector? The government? Philanthropy? Alumni? Students? The bulging bank accounts of universities themselves? There are no simple or easy answers. Even the questions aren’t as straightforward as they seem. This week, I share a brief overview of higher education and legal education economics. It is as primitive as it is brief, but it’s a start, and I hope that it’s a helpful initiation for outside observers and even for interested insiders. Next week, I’ll wrap this up.
A summary of law school and higher education economics
Part I of this document is largely a historical review, one that leans heavily on patterns of status and prestige as explanations for the institutional shape of law schools and US legal education. This Part II focuses more attention on the future, laying out opportunities and limitations associated with legal education in the context of its higher education environment.
The takeaways
1. Student quality is a variable, not a given, which means that growing the pool of tuition revenue by increasing student numbers or reducing financial aid (including discounting) likely means diluting the quality of the student body, leading to reduced rates of employability, bar passage, and possible reputational consequences and worse. There are few practical ways to increase tuition revenue associated with traditional JD students without compromising other aspects of the existing program. Likewise, it is impossible to maintain consistent student quality while increasing the population of students – without spending lots of money. “Balancing the budget” for “ordinary” law school operations is fighting the tide of structural deficits. The challenge is to secure sustainable alternative sources of funding, either internally (via state or university subsidies, and/or via net revenue from new law school programs at scale) or externally (cultivating massive gifts and grants).
2. Alternative revenue sources and captive revenue sources matter a lot to the sustainability of a 21st century law school, because the amount of “standard” tuition may be limited by the need to maintain student quality. BYU Law is not suffering; it has a functionally captive prospective student population. Texas A&M Law has thrived in recent years because it has committed to a massive expansion of online certificate education at the law school, especially in business law subjects.
3. There are hard questions ahead about reconciling competing goals and priorities and about who is making decisions about priorities and how. Priorities that came to the fore during the “golden age” of legal education are now on the table as possible question marks. What becomes of clinical education, which is vastly more expensive to support than Harvard-style “mass education”? What happens to faculty research and scholarship?
4. What about the future of law, of lawyers, and the legal profession, and should changes on those fronts influence what legal education looks like? Law schools need to significantly modernize their curriculum and their faculties. Other forms of legal education may turn out to be useful and effective. Without adaptation, and perhaps even substantial revision, law schools may face irrelevance, an exodus of prospective students, or both. Even bar examiners are re-examining some the premises of lawyer licensing, although in mostly trivial ways – so far.
The university budget environment: where the money comes from
A handful of US law schools operate on a stand-alone basis, but the vast majority exist in the context of larger organizational and budget imperatives and concerns. No discussion of the future of legal education can overlook their shadows. Important considerations begin with the following:
1. Where does the university get its own money? University revenue sources fall into three broad categories: (i) tuition and student fees; (ii) endowment income; (iii) federal sponsorship (research grants) and state subsidies (allocations).
2. Tuition and fees are universities’ primary sources of discretionary revenue, yet they are fragile sources for reasons akin to reasons that challenge law school’s tuition income: a declining pool of prospective students, given demographic trends, and concerns over affordability and student debt relative to economic payoffs of the college experience.
3. Only a handful of private colleges and universities, and an even smaller number of public universities, rely on substantial endowment income. Endowments offer universities financial stability over time, but endowments are difficult and time-consuming to build and take many years to throw off an amount of income that offers meaningful support to operations.
4. State support is eroding. Flagship public universities may receive 5%-10% of their annual operating budgets via state appropriation or allocation, down from 15%-20% as recently as 20 years ago. The optics of that small financial piece remain important; public universities may be reluctant to take the step of forgoing what may be a modest amount of money and go fully “private,” because they worry about sacrificing years of accumulated community goodwill that brings, among other things, a steady supply of new students. Yet the politics of getting that slice of public support are increasingly fraught.
5. Universities have enormous fixed costs (physical plant, faculty compensation), face practical limits on their ability to raise tuition, and cultural/historical limits on modernizing their programs. Tenure-stream faculty are expensive and inflexible; contingent faculty are much less so.
6. How does this matter to law schools? The effects vary. At “law is a small fish in a big pond” universities, law schools tend to be the first to suffer and the last to feed. Why? They contribute little to the university in economic terms (they are money sinks; the “cash cow” model is mostly at an end), and little to the university in terms of intellectual engagement or scholarship metrics. At “law is a big fish in a smaller pond” universities, law schools may be higher fiscal and programmatic priorities. Law faculty often hold on to the hope that central university administrators will continue to underwrite the law school’s budget (including possible operating losses) on the assumption that the administrators share the faculty’s belief that the law school offers “prestige value” to the university. In the current economic climate for higher education, there is little data to support that assumption.
Structural deficits and operating deficits explained, with attention to law schools
Drilling into some accounting details helps to paint a slightly richer portrait. The following terms and concepts relate to how money comes in to a law school and how a law school spends money over a typical budget year.
1. Fixed costs are things that the law school has relatively little control over but that constitute by far the larger part of its budget (faculty compensation; debt associated with construction; money transferred from the law school to the university). Faculty compensation is the largest element of the school’s fixed costs and often as much as ~70% of the school’s total budget.
2. Variable costs are things that the law school usually has relatively more control over but that constitute by far the smaller part of the law school budget (staff compensation; library books/materials; water/electricity). Student financial aid is often budgeted separately.
3. Revenue sources are tuition (either paid directly to the school or indirectly as an input into a university allocation to the law school); other fees, such as application fees; grants and gifts; endowment income (often restricted).
4. Structural deficit is a budget deficit that cannot be closed even if the organization maximizes all of its potential revenue and minimizes all of its costs, both fixed and variable.
5. Operating deficit is a budget deficit that can be closed by the organization’s raising “ordinary” revenues and/or minimizing “ordinary” costs (both fixed and variable).
6. Questions to be asked, because the answers influence interpretation of the relative significance of each of these categories. What time frame matters, meaning should a law school’s budget experience be evaluated based on annual performance? Actual or expected performance over some number of years? What programs, operations can be controlled, improved, or affected in other ways, and again, over what time frame and based on what decision making mechanism? With what impact(s), budgetary or otherwise, within the law school, within the university, and within the broader community social and economic systems that the law school identifies with?
Law school budget basics: operations
Taking the above terminology into account, the elements of a law school budget come together as a financial model in different ways.
1. Model 1: Student tuition is paid to the central administration of the university. Central allocates a sum to the law school to fund operations. This implies that Central takes a haircut (a stipulated percentage) from the tuition pool, but that implication or assumption may be mistaken; the allocation may not be related to the ways in which tuition is calculated or paid, or to other ways in which the law school receives revenue.
2. Model 2: Student tuition is paid to the law school, which is “taxed” by Central (i.e., Central takes a given percentage of the law school’s revenue, partly to cover imputed costs of services that the university provides to the law school, and partly for other reasons).
3. RCM budgeting (“Responsibility Center Management”) or other budget systems don’t matter to measuring substantive differences between Model 1 and Model 2 in terms of their impacts on a law school’s operations. Some universities have operated on RCM budgeting or the equivalent for decades (Harvard and its “every tub on its own bottom” system); others have not (Yale). RCM systems try to expose unit-specific surpluses and deficits (transparency is never a neutral value) but do not specify the direction of financial flows. (In practice, contemporary RCM use is often associated with central administration efforts to trim or even eliminate “unprofitable” academic units.) Even Harvard (Central) long wrote big checks to HLS to keep the law school afloat.
4. Tuition rules. All law schools are tuition-dependent, but with tuition discounting – even at elite private universities – tuition revenues increasingly fall far short of covering the school’s operating costs. Subsidies – from Central, and/or directly from the state (for some public universities) – have made up much of the difference. State subsidies have been decreasing. Central is getting wise to law schools’ structural deficits and putting pressure on law school deans to close them. (Closing them is often not a realistic goal, but realism often does not constrain central university administrators.) Endowments often have fixed uses (donor-specified) and often throw off only modest amounts of income.
5. Compensation costs. The expectation that law school faculty will consist of full-time professors, most of whom are eligible for tenure and most of whom conduct research and publish scholarship, comes from the Harvard model, has been baked into the structure of university and law school operations for decades, and costs law schools an enormous amount of money. In concept, law schools could cut back on the number of full-time faculty or change the balance of expectations between teaching and research in order to justify a reduction in faculty compensation. Doing that would also significantly change the character of the faculty, because the opportunity to conduct research and publish scholarship is a key factor in attracting multiple kinds of talent out of law practice and onto law faculties. It would also significantly change the character of students’ educational experiences. And the politics of institutional change in higher education make it both conceptually and practically difficult to do much on this front, even assuming that doing something on this front is wise.
The problem – discounting – in a simple illustration
Some additional essential terminology follows, relevant to the role that tuition discounting now plays in the finances of law schools.
1. The discount rate is the difference between a law school’s expected total tuition income if all students pay full freight and a law school’s actual total tuition income.
2. Assume 150 students per JD class and a published tuition rate of $30k per year. 450 students x $30k = $13.5mm. Assume that the law school actually receives all of that money.
3. Assume endowment, gifts, and university and state subsidies of $5mm total. The school’s total budget is $18.5mm.
4. The law school uses a 25% overall discount rate in distributing financial aid, so that the net revenue to the school is $10,125,000. The school’s budget (the revenue that it has the power to spend) is just over $15mm, if everything else remains constant. Discounting costs the law school roughly $3mm.
5. If the school reduces its discounting (reduces the rate; distributes aid over a larger student body; or both), it loses students who meet its academic expectations (meaning a possible decline in rankings, a possible decline in bar passage (leading to more decline in USNews rankings), a possible decline in placement at graduation (still more decline in rankings); and/or pressure on faculty to engage in more academic support, including teaching more or different “basic” skills (leading to possible loss of faculty and/or difficulty in recruiting – leading to even more decline in rankings). The emphasis on “rankings” as a consequence is meant only to make the impacts on school and student quality specific and concrete, rather than to elevate the USNews rankings to a position of strategic priority in and of themselves.
6. Virtually every dean in the US today will report – if they’re honest – that tuition discounting and competing for incoming students is their number one strategic and operational challenge. In an era of reduced enrollments, discounting costs law schools a lot of money.
I have one more installment yet to come, in conclusion. A preview: there are no answers, only choices. What’s next?