"Wise and prudent men - intelligent conservatives - have long known that in a changing world worthy institutions can be conserved only by adjusting them to the changing time."
Franklin D. Roosevelt, September 1936
I am writing this piece during the holiday break while reflecting on both the discussions and decisions over the past nine months that will set the stage for the MIT budget in Fiscal Year 2005 (July 1, 2004-June 30, 2005). Chancellor Phil Clay and I have met with almost all the academic units (we still have a few meetings scheduled in January and February) and in these sessions we have described in some detail the strategies that have been the basis for our decisions, our current financial situation, and the path forward. I know that some faculty members feel they have heard enough about these issues and want to look forward. However, it is an important exercise to understand MIT finances over the last decade and the decisions that have been made in order to extract the important lessons. I will attempt to do this in this short piece and, hopefully, help a greater number of faculty and staff understand the financing of MIT. Lastly, I hope that the presentation will enhance discussions about strategies going forward.
Before reviewing the details, I want to make sure that the basic message does not get lost in the details. MIT is intellectually and financially strong.
We have the people, money, and infrastructure to continue to be the most important research university in the world with emphasis on science, engineering and management. Our faculty and students are second to none; our programs are ranked among the very best in the world and we are both sustaining our excellence in core programs and embarking in new, exciting directions. In the last economic cycle, we used new resources to strengthen the core of MIT. In the last two years, we have made the difficult budgetary decisions necessary to find the "bottom" created by this economic down-turn, and we are positioned for growth in the years ahead.
In the second half of the twentieth century, MIT was shaped by the emergence of federal support for academic research and the development of the research university in the United States . As the system for support of private universities evolved in the last decades of the century, MIT had to face the challenge of moving a substantial portion of the support for our programs and infrastructure in science and engineering from external research support to private support. Substantial portions of the academic year salaries, funding for infrastructure, such as our library, and the cost of graduate students supported by research contracts and grants had to be supported by the Institute, and not directly from contracts and grants. This shift from sponsored research to internal support was made possible by aggressive and successful fundraising for our endowment and by a successful long-term investment strategy. The MIT endowment has increased substantially since the early 1990s, with a large portion of this increase coming from the high rates of investment returns in the second half of that decade. With this increase came the opportunity to use the increased income from the endowment to benefit the most important initiatives in the Institute. After much discussion, the core needs of the Institute were distilled in President Vest's fall 1998 report, entitled The Path to the Future . The major issues and our strategies for addressing them are summarized below:
It is easy to see that the majority of our investments have been used to fund core issues within MIT. We have not increased departmental budgets greatly, except for the increase in funds available to the academic units through increased income from their restricted endowments. We also have made $5M/yr. available each year between FY98 and FY03 for increasing general institute budgets in support of proposed initiatives. The competition for these new funds has been keen.
These investments in the core missions of the Institute seem to be reaping the benefits we had hoped for. Education and research is as vibrant as at any time I have seen. Our undergraduate student body is as excellent as any time in MIT's history. Over one-third of the faculty has joined us since 1996, bringing innovation to research and education. This faculty hiring has been made possible with tremendous investments by the departments, schools, and the Institute. Our graduate programs are thriving and research on campus has grown at the highest annualized rate we have seen in decades. The Presidential Graduate Fellowship program and increased fellowship support within departments and schools has kept our graduate recruiting competitive.
The investments also have had significant impact on MIT's annual operating budget. We have represented the expenditures associated with several of these initiatives pictorially on the plot below. Here the total on-campus operating budget for research and education (excluding Lincoln Laboratory) is displayed as a function of the fiscal year, along with the incremental portion of this budget that is associated with four parts of the core expenses described above; the Presidential Fellowship Program, the graduate tuition subsidy for RAs, the renovation budget, and the cost of new construction.
For reference, the total on-campus operating budget for FY04 is approximately $1,370M of which approximately $347M is supported by the direct cost of research. The remaining $1,025M of the budget is supported by tuition, gifts, income from the endowment and the indirect cost of research (Facilities and Administration (F&A) costs). Approximately half of the budget is the cost of compensation and employee benefits, and there will be about $50M in interest and $50M principle payments associated with capital construction.
As you can see, the largest commitment of additional budget and thus income from the endowment, has been associated with the graduate research tuition subsidy, followed by the renovation budget. The cost of new construction to the operating budget is shown in this display as net of revenues generated by each project. These revenues include rents generated by the dormitories, fees for membership in the Zesiger Center, and F&A recovery on the depreciation of research space.
The increased commitment to undergraduate financial aid is not shown in this display. The budgetary commitment is most clearly seen by examining the undergraduate self-help level. MIT has gone from a self-help level of $8600/yr. in FY97 to $5500/yr. in FY04. As a result of this policy and increases in tuition, room and board, our average scholarship level has increased by $6,000/yr. for the over 2000 needy students in our undergraduate student body.
The MIT Endowment
The investments described above have been made possible by the increase in value and, hence, in income from our endowment. Unitized in 1969, the increase in the endowment can be separated into the effect of increasing the endowment through new gifts, which is represented by the growth in the number of units of the endowment, and history of the value of an average unit, net of the distribution of funds from the endowment for operation of MIT, which represents the impact of investment growth. The history over the last 35 years of the value of an endowment unit is shown in the plot below. There are currently about 7 million units of the endowment with a unit value as of October 2003 of $788/unit.
The control of the 7 million units of the endowment is distributed across MIT approximately as follows: 2.8 million units are controlled by departments, schools, and the provost; 0.8 million units are restricted to undergraduate financial aid; and 3.4 million units are unrestricted with the income being used for the general institute budget.
The annualized appreciation of the value of a unit of the endowment is over 6% per year over the 35-year period. When distributions are included, the annualized rate of return is over 10%. The distribution from the endowment to the operating budget tracks the unit value according to a distribution rule proposed by the Investment Committee of the Corporation and voted by the Executive Committee. The distribution has increased from approximately $12/unit in FY91 to a high of $42 unit in FY03.
Even with this increase in the distribution from the endowment, we would not have been able to accomplish the agenda described above without two important developments in the financing of MIT. In a plan crafted between 1998 and 2000, the Executive Committee agreed that it would be appropriate to spend an additional increment of endowment over the decade, FY01-FY10, for the core needs of the Institute. This additional allocation amounts to a de-capitalization of unrestricted endowment outside the funds distributed through the distribution rule. By agreement this amount has been set at $500M with increments of the expenditure budgeted on an annual basis.
Second, after extensive discussions with the academic units, the deans, and the Executive Committee, MIT instituted an annual service cost on specific endowment accounts to fund core needs that can be directly associated with the accounts; e.g., association of the RA tuition subsidy with faculty professorships. This service cost is presently set at 25% of the annual distribution from appropriate accounts.
The value of a unit of the endowment has decreased for each of the last three years and our financial planning for the performance of the endowment this fiscal year (FY04) assumes conservative returns this year. The decline in the unit value has necessitated a drop in the distribution from the endowment. The distribution in FY05 is expected to decrease from $41/unit in FY04 to $36/unit in FY05. These decreases should be put in context of the robust increases of the last few years; for example, the distribution rate in FY98 was $18/unit.
Basics of MIT Operating Budget
The annual MIT operating budget relies on revenues from tuition, research (through F&A), gifts, and income from the endowment to pay for the $1,025M of expenses. Several of these revenues are highly constrained. MIT's undergraduate tuition is among the highest in the United States and revenues from tuition, net of the financial aid demands, are not expected to increase at more than a nominal rate. Because the indirect costs of research are a set of expenses agreed upon with our federal auditors, increased research volume does not give MIT greater financial leverage. If the costs of research (for space and administration) stay the same, increasing the research volume decreases the F&A rate. We have seen this dynamic over the last several years as the F&A rate has decreased from 63.5% in FY98 to 60% in FY04.
Simply stated, growth in the operating budgets at rates greater than the nominal inflation rate has to be supported by increases in gifts and income from the endowment.
The stress on the operating budget in FY04 and FY05 is caused by a combination of the down-turn in investment income and by increased expenses. There are several categories of expense increase that go beyond those described above. Most notable is the cost of our employee benefits, which has seen substantial increases because of a combination of health care costs and the investment returns on our defined benefit pension fund. As a result, the employee benefit rate charged to all compensation, both internally and direct charged to sponsored research, has risen from 18% in FY97 to a projected 25% in FY05. The cost to the MIT operating budget of this increase is projected at $25M/yr next year.
Adjustments in Operating Budget for FY05.
Developing budgets for FY04 and FY05 has been challenging, because of the need to compensate for the continued decline in endowment income without compromising the core values and excellence of MIT and the momentum that has been established in the last decade. The FY04 budget that we have in place for this year included almost $39M/yr. reallocations of revenues and budget reductions.
Those changes that were most felt by the academic and administrative units were a $1/unit reduction in distributed income (a loss of $2.8M/yr. in revenue to units), $4M/yr. reduction in funds available for the academic budgets, and $13.3 M/yr. reductions in administrative budgets. Many academic units also were hit hard by changes in interest income rules on unspent fund balances.
Developing the FY05 budget has been much more difficult, because the magnitude of the adjustment needed between revenues and expenses is about $70M/yr. We began this process in the spring of 2003 with a presentation at the April faculty meeting and worked together throughout the summer and fall to come to where we are today. Instead of discussing the changes in sequence, I think it will be more valuable to talk about the impact on specific programmatic areas in the context of these changes.
These changes can be categorized in terms of:
Undergraduate Financial Aid . One decision seemed very straightforward. The Institute's commitment to undergraduate financial aid is unchanged. Although lowering the self-help level further does not seem possible in FY05, we are committed to maintaining the current level of undergraduate financial aid. The decrease in endowment income will force a larger portion of this aid to come from the general institute budget instead of endowment income that is restricted to undergraduate scholarships. We estimate that the additional funding needed in FY05 will be approximately $20M.
Support for Graduate Students and Graduate Research . One of the major points of concern is the impact of the current financial situation on our graduate programs and on graduate student-based research. Several changes have impacted the cost of graduate student-based research. First, starting in FY05, the tuition subsidy on graduate research assistants will decrease from 65% to 50%, resulting in an increase of the cost of a graduate student to a contract or grant by over $4000/yr. This increase puts pressure on the cost of graduate students on contracts and grants at a time when the rising cost of health insurance and the cost of living is making it increasingly difficult for graduate students to live on their stipends. This issue needs to be resolved. Hopefully, by the time this article is printed, we will have a plan that helps graduate students to cope with the increasing cost of health care, and faculty to deal with the pressure on the cost to contracts and grants.
Also, as planned, the support from the general institute budget for the Presidential Fellowship Program concluded in FY03, and the Program continued this year with funding from endowment raised for this purpose and with discretionary allocations from the provost. The number of Presidential Fellows decreased from a high of 171 in FY03 to 72 in FY04. Because of increased gifts, we have allocated a total of 112 Presidential Fellows for FY05. Although the total number of presidential fellowships is ridiculously small relative to the size of the incoming graduate student class for the Institute, the program has demonstrated that the need for graduate fellowship support is becoming more pronounced across much of MIT. Many departments rely on these fellowships for recruiting the very best graduate students and for sustaining the funding system for doctoral education. The message here is clear: MIT must continue the campaign for graduate fellowship support in the years ahead.
Academic and Administrative Budgets. Academic units were given planning information in May 2003 to begin planning for the decreased endowment distribution in FY05. The impact is substantial, translating into $10.5M/yr. in decreased revenues to the academic units. Although painful, we believe this decrease can be accommodated, because of the substantial increases over the last five years. The planning for these decreases and their impact falls totally on academic units that have endowment income.
Decreases to academic and administrative unit budgets are needed to compensate for the loss of income from unrestricted endowment, from the decreased income from the service costs, and by the cost increases to the Institute. The aggregate decrease in the budgets for academic units is $11M/yr. These are distributed as follows:
The budget reductions in the administrative units (e.g., Information Systems, Human Resources, Facilities, etc.) are much more severe and amount to over a $25M/yr. decrease in expenses, including contributions from student dining and housing. These changes will lead to a substantial number of layoffs and some realignment of services. Much of the month of January will be spent finalizing these changes and communicating to the community potential impacts. We are very sensitive to the potential for adverse consequences in one unit caused by a budget reduction in another, and we are analyzing the impacts of all the proposed reductions to minimize these impacts.
Salary Freeze . After the changes in costs and reductions in revenues and expenses described above, the approximately $70M gap was reduced to approximately $10M. Two choices remained; either reducing the academic budgets an additional $10M/yr. or freezing salaries for all except those with the lowest compensation levels. We presented these alternatives at the September faculty meeting and discussed the consequences throughout October. Although the decision to freeze salaries was difficult, it seems the right one compared to the severe consequences of an additional budget reduction of this magnitude, which would negatively impact our programs and lead to substantial staff reductions. The trade-off against these reductions was to forego a small (2-3%) salary increase for all employees making over $55,000 per year.
I hope that with this article all understand the FY05 budget, and let us begin to turn our attention to the future of MIT. Each time I talk with colleagues about MIT's financial planning I worry that I am unsuccessful in making clear the underlying principles, at laying out the options and trade-offs, and at engaging others in the discussion. The important strategic issues are critical; however, in each discussion there are questions asking for more detail. MIT is a data driven environment.
The important messages are simple. The financial planning and the budgeting for FY05 have been put in place to bring expenditures in line with our expected revenues. With these changes and with reasonable economic conditions and investment returns, the MIT budget should be able to grow at a steady rate in the years ahead . Our continued excellence and competitive position are not in question.
Will there be enough growth to satisfy all demands? This is obviously not feasible. The finiteness of our resources will continually constrain our seemingly unlimited ambitions. This constraint, more than any other, forces us to continuously rethink the core values of MIT, to define the institution we must be and what we should not attempt to do. We must continue to do this self-evaluation, to find more ways to engage as many of our faculty who are willing in this discussion, and to continue to redefine this unique Institute into the twenty-first century. If we do this, MIT will continue to be the very best university of its type in the world.