Challenges to Full-Cost Recovery

There is often a gap between what funders pay for indirect costs and the actual costs incurred. While cost-sharing can be a programmatically appropriate condition for some types of funding, it is not a sustainable practice over the long-term when seeking to maintain the infrastructure and excellence of an academic research enterprise.

"Even if universities did receive the full, negotiated rate, it would still be less than the actual costs of supporting research."

While indirect costs are typically reimbursed according to UC campus's federally-negotiated rate agreements for federally-funded research projects and application of these rates is used as a proxy for "full-recovery" of indirect costs, a 2014 Nature article, citing Council on Governmental Relations (COGR) president Tony DeCrappeo, notes that "even if universities did receive the full, negotiated rate, it would still be less than the actual costs of supporting research." An administrative cap built into every federally-negotiated indirect cost rate agreements, inconsistency in the rate-setting process, and authorized agency deviations from the application of a negotiated rate agreement in certain circumstances together challenge the ability to recover the full costs of research.

The federal government placed a 26% cap on the administrative component of universities' rate agreements in 1991, resulting in the under-recovery of costs associated with administrative and oversight burdens of 21st century science - universities are the only federal funding recipients to have such a cap. According to a 2010 United States Government Accountability Office (GAO) Report titled Policies for the Reimbursement of Indirect Costs Need to Be Updated"about 83 percent of schools had fiscal year 2007 administrative costs above the administrative cap, with a reported average administrative rate component of 31 percent." Since the GAO report was written, the complexity of federal grant administration has grown with additional reporting and regulatory requirements for conducting research projects.

The GAO also noted inconsistency in the rate-setting process, handled either by the Department of Health and Human Services (DHHS) or the Office of Naval Research (ONR). Universities propose indirect cost rates based on the application of federal costing principles, currently Uniform Guidance (2 CFR 200), previously OMB Circular A-21. However, cognizant federal agencies (in the case of UC, DHHS) negotiate with universities, resulting in agreements with rates generally lower than initially proposed by universities despite applying these costing principles. In its report, GAO asks that "methods [be identified] to ensure that the rate-setting process is applied consistently at all schools, regardless of which agency has rate cognizance. This would include identifying ways to ensure that differences in cognizant rate-setting agencies’ approaches, goals, policies, and practices do not lead to unintended differences in schools’ rate reductions for indirect costs."

2 CFR 200.414 states that negotiated indirect cost rates "must be accepted by all Federal awarding agencies," but permits a different rate be used when obligated by statute or regulation, or when justified and approved by a Federal agency head. For example, the National Institutes of Health limits indirect cost recovery to eight percent of the Modified Total Direct Costs (MTDC) for large training grants. When UC accepts these types of awards, it is not recovering sufficient funds to cover all of the indirect costs associated with activites under these grants.

Although the federally-negotiated rates yield less recovery than actual full-cost recovery, the University considers the application of our federally-negotiated rate agreements proxies for full cost recovery.

"The overhead fiction also results from well-intended metrics developed by nonprofit watchdog groups that have equated lower overhead with organizational effectiveness when, in fact, the opposite may be true."

Many funders, such as foundations, donors and even for-profit corporations, may have policies that do not permit the reimbursement of indirect costs, widening the discrepancy between actual costs and recovered costs even more. Because indirect costs can't be easily attributed to a specific project, some funders view them as evidence of waste or inefficiency and don't reimburse them at even the federally negotiated rate.

In a 2015 announcement regarding the Ford Foundation's indirect cost recovery policy, Darren Walker, President of the Ford Foundation, talks about "the overhead fiction,"

All of us in the nonprofit ecosystem are party to a charade with terrible consequences—what we might call the “overhead fiction.” Simply put, because of this fiction, foundations, governments, and donors force nonprofits to submit proposals that do not include the actual costs of the projects we’re funding.

I recently learned of one local government request for proposals that gave extra points to applicants that submitted proposals with lower overhead, resulting in the winning groups receiving overhead payments of 5 percent—an absurd and self-defeating outcome.

The overhead fiction also results from well-intended metrics developed by nonprofit watchdog groups that have equated lower overhead with organizational effectiveness when, in fact, the opposite may be true.At Ford, we have been willing participants in this charade. Our policy of 10 percent overhead on project grants in no way allows for covering the actual costs to administer a project. And to be honest, we’ve known it.

This number does not reflect what it takes to actually manage a project; nor does it help those we support to effectively run robust organizations capable of executing projects. Thus, beginning January 1, we will double our overhead rate on project grants to 20 percent. We hope to encourage more honest dialogue about the actual operating costs of nonprofit organizations working in the US and internationally.

Nonprofit organizations properly seek to keep their overhead low, but in many cases their policies on indirect cost recovery fail to take into account the differences between the demands of their functions (primarily fundraising, grant-making, and advocacy) and those of an organization like a university, where the costs of specialized research labs and administration enable the science that outside funders seek to catalyze. 

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