Hurricane Helene caused widespread destruction across the Fifth District. Two community college presidents in North Carolina shared how the storm impacted their institutions and the role they have played in the recovery efforts.
Success Measures Matter: How States Are Tying Funding to Student Outcomes
State appropriations are an important source of funding for community colleges. As we've written before, most state funding for higher education has flowed to public institutions based solely on full-time equivalent (FTE) enrollment, which quantifies the number of students attending the institution irrespective of outcomes or attainment. Increased attention on value and quality in higher education has accelerated the rise of outcomes-based funding, also called performance-based funding (PBF). These models allow a portion of state higher education appropriations to be dispersed based on student success outcomes like completing credits, staying in school, graduating, and landing a job. In theory, PBF policies are designed to incentivize institutions to spend their financial resources efficiently. In return for meeting a set of performance metrics, institutions receive additional revenue. However, designing and implementing PBF models that align state, institutional, and student outcomes is complex.
The Landscape of Performance-Based Funding
Performance-based funding (PBF) has a long history in the United States and has gone through different iterations. The first wave of these funding models — sometimes called "PBF 1.0" — awarded institutions bonus financial incentives if they hit certain performance targets. These bonus amounts were awarded in addition to an institution's enrollment-driven base funding and tended to be small in comparison. Therefore, PBF 1.0 did relatively little to incentivize institutions to achieve the state-determined target metrics.
In the more recent wave of PBF models — "PBF 2.0" — states integrate performance metrics into base funding formulas rather than including them as bonus incentives. In PBF 2.0, institutions have the opportunity to increase their annual base funding amount by meeting the given targets. Conversely, institutions are also at risk of seeing their base funding level shrink if they fail to meet the targets.
The State Higher Education Executive Officers recently began collecting data on states' PBF allocations as part of the annual State Higher Education Finance report. In FY2023, 28 states used PBF to distribute higher education funding. PBF allocations represented approximately 9.5 percent of total U.S. public higher education funding for four-year institutions and 10.2 percent of funding for two-year public institutions. Shares varied significantly across states and across higher education sectors within states.
In the Fifth District, only North Carolina and South Carolina had PBF allocations in FY2023. However, states in the Fifth District and beyond are increasingly exploring policies that tie funding to outcomes in higher education.
As of 2024, more than 30 states are implementing PBF in some form. Most states use a blended or hybrid approach, combining one or more performance incentive models with the more traditional enrollment-driven funding formulas. However, other states have yet to make the switch because they're unsure whether outcomes-based funding would benefit their institutions (or if it would have any effect on student outcomes).
The Appeal of Using Outcomes to Determine Funding
Since the PBF funding model relies on incentives (e.g., the institution awards a certain number of associate degrees or short-term certificates), more and more states are investing in PBF in an effort to improve outcomes and achieve long-term goals. In addition to a blended or hybrid approach, it's not one-size-fits-all: States can tailor the outcome metrics to include milestones, the time taken to earn a degree, or even the type of degree — such as those in high-demand fields that meet local workforce needs. Below are some reasons states are enacting PBF:
- Coalescing state agencies around unifying goals: This varies by state, but states that are investing (or thinking of investing) in outcomes-based funding are looking at improvements in funding methods and developing a framework to aid in the model's success. In Minnesota, the House Research Department developed statewide objectives for PBF in higher education that aim to 1) ensure quality; 2) foster student success; 3) promote democratic values; 4) maintain access; and 5) enhance the economy.
- Driving institutions to focus on high-demand fields: One reason states set performance metrics for higher education institutions is to reduce workforce shortages in key industries and shore up the future workforce pipeline. Because appropriations can vary, there are more incentives for states to prioritize outcomes-based funding based on performance indicators and pair it with workforce development incentives. The Kentucky Community and Technical College System and the state's public universities receive 35 percent of their state appropriations from meeting success outcomes in STEM and health; preparing students for high-paying and high-demand jobs; and receiving credentials from the Education and Workforce Development Cabinet.
- Ensuring positive return on investment: By using monetary incentives, states can work to ensure that taxpayer money is spent judiciously on higher education. PBF may also benefit students as institutions focus on supporting students to enroll in and complete programs that will offer robust career opportunities. In 2023, Texas took the next step toward an outcomes-based funding model that focuses support on community colleges providing "credentials of value," meaning community colleges can receive more credentials-based funding when students earn jobs in high-demand industries; students successfully transfer to four-year universities; and high school students receive dual credit.
Challenges to Successfully Putting Theory into Practice
In theory, PBF policies motivate higher education institutions to produce outcomes that are aligned with state-level priorities to maximize the impact of public spending. In practice, identifying the performance metrics that ensure state appropriations yield a high rate of return across all eligible institutions within the state is challenge. It is especially challenging to determine outcomes appropriate for community colleges' unique role in higher education and the unique workforce needs in their respective service areas. Below are some barriers to developing PBF policies reported by states:
- Taking a one-size-fits-all approach to identifying outcomes: One argument against outcomes-based funding policies is that they are too focused on degree completion instead of the progress toward that degree. In some cases, schools might prioritize quantity over quality for degree completion and therefore not align students with local workforce needs. Institutions chasing completion or graduation numbers may be pushed to drive students toward programs that they are most likely to complete rather than programs best aligned with students' long-term goals. For community colleges, which are deeply tied to their local employers, this may run counter to their institutional mission. One solution some community colleges are offering is partnering with local employers to determine what short-term certifications are needed to support the local workforce (though this could mean eliminating other programs).
- Holding higher education accountable for complex outcomes: There's also concern about the difficulty in measuring labor market success (e.g., getting a job) and separating that from graduation rates. Texas State Technical College has modified its outcomes-based funding to award the college with appropriations based on the workforce earnings of its graduates. There are often administrative hurdles to linking earnings to credential attainment, especially for students earning non-credit workforce credentials. As with gainful employment policies, measuring the value of a credential based on wages often disadvantages rural students and those earning early-career credentials in high-paying fields like nursing.
- De-prioritizing equitable access and support: Some community colleges and four-year universities have reported unintended consequences of PBF, including restricting admissions requirements and weakening academic qualifications. Both could affect workforce preparedness, especially for trade occupations and programs offered through community colleges. In the last decade, researchers have found that minority-serving institutions with outcomes-based funding lose more money compared to other state institutions because of the resource and funding allocation. This 2021 report suggests that states should implement metrics focused on enrollment and success by race and socioeconomic status to keep equitable access a priority.
The Future is Performance-Based Funding?
Are PBF models the best approach to align incentives across higher education institutions, students, and the labor market? The answer to that is — as it often is in policy discussions — it depends. In most states, PBF accounts for a relatively small share of state higher education funding but continues to arise in state legislatures eager to prioritize spending on activities that fuel economic growth and support state workforce needs. Higher education institutions are charged with educating students and successfully preparing them for the workforce, but there is no one-size-fits-all approach to measuring success. Finding the right balance between incentivizing institutions to reach important targets while allowing them to fulfill their institutional missions and meet the needs of their students remains a challenge.
For community colleges, the stakes around performance-based funding are high. State appropriations are a key funding source for community colleges and even a small one-year dip in state funding can affect programs and services for students. Community colleges serve students in distinct regions with variable workforce needs, meaning that measuring colleges and their students against a single static metric may undervalue some types of community college success. In the coming months, we will dig deeper into trends in higher education funding and how state governments, higher education authorities, and community college leaders are working to align incentives to improve student outcomes
Views expressed are those of the author(s) and do not necessarily reflect those of the Federal Reserve Bank of Richmond or the Federal Reserve System.
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