[CRS Issue Brief for Congress]

91095: Indirect Costs at Academic Institutions: Background and Controversy

Updated January 3, 1997

Genevieve J. Knezo
Science Policy Research Division

CONTENTS

SUMMARY

MOST RECENT DEVELOPMENTS

BACKGROUND AND ANALYSIS

Indirect Cost Rates and Federal Indirect Cost Reimbursements
Indirect Cost Rate Negotiations
Circular A-21
Allegedly Fraudulent Billing
Indirect Cost Rate Determination: Policy Debates
Equality of Rates Universities Charge Performers
Lack of Uniformity in Accounting and Auditing; Proposals to Fix Rates
Changes in Circular A-21; Other Proposals
Facilities-related Indirect Costs
Administrative Costs
Proposals for Caps and Pauses; Congressional Outlook
Other Options to Lower Rates
Indirect Cost Rates for Other Performers

CONGRESSIONAL HEARINGS, REPORTS, AND DOCUMENTS


SUMMARY

Federal R&D funding at academic institutions totals over $10 billion annually. About one-third pays for indirect costs or overhead; the rest supports the direct costs of conducting R&D. On May 8, 1996, OMB revised Circular A-21, governing indirect costs policies, to change the designation "indirect costs" to "facilities and administrative costs" (F&A). The Departments of Defense and of Health and Human Services negotiate to determine indirect cost rates with about 96% of U.S. and audit compliance -- DOD with a few schools and HHS with hundreds. F&A costs encompass such items as facilities maintenance and renewal, heating and cooling, libraries, salaries of administrators, and student support.

There are questions about the increasing amount of appropriated R&D funds that go to F&A costs of academic research, the proportionately decreased funding going directly to researchers, and the decrease in oversight of federal R&D funds for academia. Many institutions protest cuts in F&A rates saying that the U.S. academic research enterprise will be weakened if the government does not pay the full costs of research it funds. Some attribute increases in tuition rates to schools having to pay more F&A costs with their own funds. For FY1994, the Clinton Administration proposed to limit overhead charges agencies could pay to save $1.2 billion over 4 years, but budget proposals did not reflect this intention. The FY1995 budget proposed to "cap," for 1 year, overhead reimbursements to universities at the amounts claimed in 1994. This generated strong opposition from academe. CBO proposed to cap rates at 90% of the FY1996 level.

A few years ago, congressional investigations and audits revealed hundreds of millions of dollars of inappropriate charges for indirect costs. Some researchers allege this is due to inefficiency by administrators. Indirect cost recoveries for facilities are rising faster than for other indirect costs; Legislation introduced in the 103rd Congress provided direct funding for facilities. OMB Circular A-21 governs F&A rates. In 1991, OMB revised it to specify unallowable costs, prohibit the federal government from being charged for overhead costs incurred by other sponsors, cap administrative costs at 26% of modified direct costs, seek more uniformity in indirect cost rate calculations, and require facilitiesrelated indirect cost recoveries to go only to facilities renewal. NIH announced it would assess indirect costs in deciding to award funds for research. In 1992, GAO attributed unallowable indirect costs largely to ambiguities and inconsistencies in rate determination and recommended use of one agency, one consistent approach, and capping of rates. 1993 revisions to Circular A-21 aggregated the rate into two parts, administrative, already capped at 26% of modified total direct costs; and facilities. During 1995, legislation was introduced to both prohibit and permit caps on indirect costs rates.

On February 6, 1995, the Administration proposed to revise Circular A-21 to standardize and make more efficient the way some costs are calculated and to develop standards and priorities for allowable facilities reimbursements. The final revisions, which also prohibit deduction of tuition for faculty dependents, were published on May 8, 1996. OSTP's study of university-government relations includes the topic of streamlining regulatory procedures; it is due on June 30, 1997.


MOST RECENT DEVELOPMENTS

The issue of reducing indirect (now called F&A) costs resonates in appropriations debates since R&D funding is being reduced. No fundamental legislative changes have been enacted recently. H.R. 3322, 104th Congress, the Omnibus Civilian Science Act, which would have authorized the National Science Foundation and other agencies for FY1997, required the Office of Science and Technology Policy (OSTP) to develop options to reduce by 10% federal reimbursements to universities for indirect costs and to reduce the variation in rates among institutions. (H.Rept. 104-550, Pt. 1.) In June 1995, OMB issued a memo to equalize federal requirements for equipment cost thresholds for capitalization, which will reduce administrative costs as calculated in OMB Circular A-21, which governs F&A costs. In March 1995, GAO reported that 1993 revisions to Circular A-21, which capped administrative costs at 26% of modified total direct costs (MTDC), reduced federal indirect costs reimbursements by $104 million for FY1993. Both GAO and CBO have identified additional options to reduce rates further. On February 6, 1995, the Clinton Administration proposed revisions to Circular A-21. Final revisions to the rule were issued on May 8, 1996. They require all awards to be governed by Cost Accounting Standards, replace the ambiguous term "indirect costs" with the terms "facilities and administrative costs," standardize and make more efficient the way some costs are calculated, eliminate special studies to determine some reimbursement rates, eliminate the allowability of deduction tuition subsidies for dependents of employees, and establish more rigid criteria for reimbursement. Proposed provisions to develop standards and benchmarks for facilities reimbursements and other facilities and equipment costs were not included, pending further study. OSTP's study of universitygovernment relationships, due June 30, 1997, will assess ways to minimize costs and paperwork while maintaining accountability for use of public funds.


BACKGROUND AND ANALYSIS

Indirect Cost Rates and Federal Indirect Cost Reimbursements

Federal policy for research, which was formulated during the late 1940s and early 1950s, established a dependence on universities and colleges as performers of U.S. Government-sponsored research. Academic institutions are the single largest performer of Federal research, receiving about 40% of all federal research funds. Universities conduct about 50% of all federally funded basic research, about 24% of all federal applied research, and less than 2% of federal development. Concomitant with the federal dependence on universities for research performance was the commitment that the government should help pay for the infrastructure universities need to conduct research -- buildings, personnel and maintenance. During the 1960s the federal government instituted relatively generous institutional support programs for construction and infrastructure development, while, at the same time, allowing reimbursement for maintenance and other overhead costs.

The direct costs of academic research consist of payment for salaries, large pieces of equipment, and other direct costs of conducting research. Academic institutions also are allowed to charge the government for the overhead or indirect costs, now called "facilities and administrative" (F&A) costs, such as for facilities heating, cooling, libraries and administration, incurred in conducting research and development (R&D) that the government sponsors or purchases via either grants or contracts. The F&A rate also includes a portion of regular operating costs that the university normally incurs in teaching and daily operations. Until 1966, Congress had statutorily limited all indirect cost (also called "allocated overhead payments" and now called facilities and administrative F&A) recovery rates. The last cap was 20% of direct costs; Congress abolished this cap in 1966 and, at the same time, began a policy of prohibiting educational institutions from being reimbursed for the full costs of research and requiring cost sharing on the grounds that the government is not purchasing research, but is assisting it. (Cost Sharing and Indirect Costs. In Strengthening the Government-University Partnership in Science. Washington, National Academy Press, 1983. p. 117-232, See p. 221 regarding the HEW Appropriations Act, 1966 which mandated policy changes.) In the 1970s, the federal government stopped funding the large academic institutional support and facilities building programs (such as those authorized by Title VII of the Higher Education Act) which several agencies had administered. As a result, more schools began funding facilities restoration and construction via the indirect cost route. By the mid-1980s, the government removed most cost sharing requirements. In 1970 the average indirect cost rate was about 30% of modified total direct costs (MTDC). (OMB Circular A-21, which agencies use to calculate indirect cost rates, requires that certain charges such as equipment and subcontract costs in excess of $25,000 be subtracted from the total direct costs before indirect costs are calculated. This is the modified total direct cost.) The Congressional Budget Office (CBO), in its 1994 report, Reducing the Deficit: Spending and Revenue Options, reported that in 1972, "each dollar of direct research funding paid to universities carried an additional 30 cents to cover the overhead costs allocated to federal research." After leveling off in the late 1980s, by 1994 "the government paid 44 cents in indirect costs for each dollar spent on direct research." (CBO, Reducing the Deficit: Spending and Revenue Options, August 1996, p. 317.) This means that almost one-third of each federal dollar of academic R&D support goes for indirect costs, or one-third of $10 billion, more than $3 billion. By the late 1980s the average indirect cost rate rose to about 52-53%, and now is over 50%, ranging from a low of 28% to a high of 85% of modified total direct costs. According to the CBO, "the overhead payments for federally sponsored university research have increased faster than the direct costs of research, which have themselves increased faster than the general rate of inflation in the larger economy."(Reducing the Deficit; Spending and Revenue Options, Feb. 1993, p. 198.) According to OMB, from 1970 to 1985, direct federal payments to universities for the conduct of R&D fell from 78% to 69% of total funds awarded to universities, meaning that, over these years, there was an annual shift of more than $500 million from research to indirect costs payments to academic institutions.

F&A rates are pre-negotiated and vary from school to school. Agencies do not maintain reliable consistent data on F&A costs reimbursements. Generally, F&A rates are higher at private schools, at an average of 61%, than at public schools, at an average of 48%, since state governments reimburse for overhead and facilities construction. Typically, the highest overhead rates are for medical schools. (According to an HHS report, Howard University proposed the highest indirect cost rate for 1991 at 122%. This was reduced to 63% for FY 1994. Harvard Medical School's proposed rate for 1991 was at 104%, which the school subsequently adjusted to a proposed 94%, which was reduced to 83% for FY1994. See: DHHS. Office of Inspector General. Federal Funding to Colleges and Universities in Support of Research. May 1991, p. I-40 and DHHS. The Top 116 Colleges and University for FY 1994-IDCR.) Typically, a larger proportion of the funds NIH awards for research goes to indirect costs than to direct costs in comparison with the National Science Foundation (NSF) or other agencies.

Allowable indirect costs within the pre-negotiated rate normally are documented in the budget of a proposal submitted to a federal agency for an R&D award. Up until 1987, the National Institutes of Health did not require investigators to include indirect costs in proposal budgets; therefore peer reviewers and program managers, in effect, did not have an opportunity to judge this kind of proposed expenditure. Now NIH and the NSF require indirect costs to be identified and to be evaluated. In September 1991, NIH announced that peer reviewers and advisory councils should also consider total costs (including indirect costs) in ranking and selecting proposals, (NIH Guide for Grants and Contracts, September 6, 1991). In the FY1996 budget, the President proposed to require all federal science funding agencies to review all costs, including indirect costs, during the "competitive award process. . . ." More agencies are now considering indirect (F&A) costs during a competitive procurement process.

According to HHS, the average 1990 negotiated indirect cost rate for the schools it monitors was 51% even though the average rate schools had proposed for 1991 was 59%. HHS reports that "the approximate savings that result from a single percentage point reduction of the mean indirect cost rate nationwide is $43 million." The average rate for HHS schools rose from 44% in 1982 to 51% in 1991, a cost increase of about $308 million. (Federal Funding to Colleges and Universities in Support of Research.) Other types of organizations often charge higher indirect cost rates than universities. According to CBO, In FY 1994 the NIH paid an average of 51% in indirect cost rates to universities and colleges, 63% to hospitals, 56 % to for-profit organizations, and 45% to non-profit organizations.

Indirect Cost Rate Negotiations

A school's F&A rate is composed of several categories of cost rates for similar kinds of expenses which are "pooled" together. HHS's Office of Inspector General reported approximate average 5-year ratios for indirect cost components, expressed as a percentage of the total rate. The data show that almost 54% of academic indirect cost payments were for three types of "pooled" administrative expenses, including general administration (15%), sponsored projects administration (6.5%), and departmental administration (32.2%). Other categories and their average percentage as part of the indirect cost rate were: libraries (4%), facilities plant operation and maintenance (28%); depreciation and/or use allowance (10%); and student services (1%). Some of these cost categories are capped at maximum allowable rates, expressed as percentages of the total modified direct cost. Pursuant to Circular A-21, salaries and fringe benefits of departmental administrators are fixed at about 3.6% of modified total direct costs. In October 1991, OMB limited administrative costs to 26% of modified direct costs.

F&A cost rates are calculated and negotiated periodically. They are complex and vary among institutions. Rates, negotiated annually or in some cases for several years, are based on allowable charges, past experiences and future expected costs. Usually each agency pays the same F&A rate to a given institution (although branches and off campus rates may vary), except for the Dept. of Agriculture, which uses cost formulas for different schools. (In addition, Congress in a series of appropriations acts limited indirect cost reimbursements made on grants by the Cooperative State Research Service (now the Cooperative State Research, Education, and Extension Service) of the Dept. of Agriculture to 14% of the total federal payments for a project and for other parts of the Agriculture Dept. to 10% of direct costs negotiated for cooperative agreements. The FY1996 rate was enacted in P.L. 104-37 and the FY1997 rate in P.L. 104-180.)

The Office of Naval Research (ONR) and the Department of Health and Human Services (HHS) negotiate overhead rates with educational institutions. Pursuant to changes made in Circular A-21 in 1996, an institution's rate is now negotiated by which of these two agencies awards more funds to an institution. Cognizance defaults to HHS if neither agency awards funds to the school; exceptions may be made. Transfers of new cognizant agency responsibilities have not been completed. Before this change HHS negotiated rates with about 80% of the nation's academic institutions; ONR handled fewer and primarily the largest, most research intensive, non-medical schools, such as the California Institute of Technology, Stanford and the Massachusetts Institute of Technology. As of January 1, 1990, Circular A-133 required schools to have an independent audit of their federal funding every 2 years, to be submitted to the federal agency. Previously schools could audit themselves and had the discretion not to send the report to the cognizant federal agency. Now, with passage of the Single Audit Act Amendments of 1996, P.L. 104-156, audits after June 30, 1997 will be triggered by a school's expenditure of federal funds in excess of $300,000 and will be sent to the Federal Audit Clearinghouse, which will submit the report to a funding agency if there is an auditor finding (problem). Agencies, like the DCAA, can still audit recipients.

Circular A-21

The guidelines for calculating costs are embodied in OMB Circular A-21, Cost Principles for Educational Institutions. Some observers, for instance, the Inspector General of the Department of Health and Human Services, Richard P. Kusserow, faulted the Circular, saying it did not keep ". . . pace with changes in the scientific research arena" and that it did not reflect good business and accounting practices. He charged it was ambiguous and that "Costs are considered reasonable if the nature of the goods or services acquired or applied. . .reflect the action that a prudent person would have taken under the circumstances prevailing at the time the decision to incur the cost was made." He concluded "This subjective test of reasonableness provides great latitude for schools to include many items and services which might otherwise be excluded under the more specific Federal acquisition regulations. A cost is allocable to a specific project if `the goods or services are chargeable or assignable to such cost objectives in accordance with relative benefits received or other equitable relationship.' Again, the non-specificity of A-21 provides discretion and, indeed, incentives to schools to define `benefits received' to their best advantage." (Federal Funding to Colleges and Universities In Support of Research, p. I-3,I-5.)

Some observers believe that these ambiguities fostered improper or fradulent billing practices. Revised regulations issued on Oct. 3, 1991, excluded certain items from indirect cost rate calculations and removed ambiguities in interpretation. An OMB task force sought to coordinate indirect cost reimbursement strategies with Costs Accounting Standards Board requirements for federal research contracts. (OMB Release. OMB Proposes to Cap Reimbursement of University Administrative Costs, May 15, 1991. 2 p.) It assessed ways to promote administrative efficiency; looked at institutional and geographic differences in indirect cost payment policies; examined whether payment for facilities and equipment should vary by fields of research and/or rated obsolescence; and whether elements should be reassigned from indirect costs to direct costs accounts. Its work resulted in publication in the Federal Register on December 9, 1992 of proposed revisions to Circular A-21, which, with a few technical revisions, were published on July 26, 1993. (Conforming Cost Accounting Standards Board standards for contracts with educational institutions were published in the Federal Register on November 8, 1994.) Changes made in 1996 to Circular A-21 require university grantees to use uniform accounting methods since all university support awards designated "sponsored agreements" are to be regulated by government Cost Accounting Standards (CAS).

Allegedly Fraudulent Billing

Fraudulent billings according to CBO account for about only about 1% of overhead payments reimbursements. A 1995 HHS audit of 17 educational and nonprofit institutions resulted in $179 million in "overstated indirect costs rate proposals" for FY1992 and FY1993, according to the Washington Fax, March 23, 1995. Hearings were held by the Subcommittee on Oversight and Investigation of the House Committee on Energy and Commerce (March 13, April 16, and May 9, 1991 and January 29, 1992) and by the Subcommittee on Science of the House Committee on Science, Space , and Technology (April 23 and 25, 1991) to examine inappropriate billing and policy for indirect costs. The investigative hearings focused initially on Stanford University, but GAO, HHS and other agencies audited the indirect cost billing and reimbursements of many other schools. An HHS audit found $14 million in inappropriate billings in the first 13 schools that were audited, resulting in improper overhead charges to the federal government of between $1.9 and $2.4 million for a oneyear period. Testimony at hearings held in January 1992 indicated several hundred million dollars in allegedly inappropriate billings for such items as antique commodes, flower arrangements, depreciation on a 72-foot yacht, refurbishing a grand piano, modernization of the university president's home, payment for a wedding reception for the president's new wife, construction of a new alumni club, jewelry store charges, and salary for the president's cook. While some of these costs may have been related to allowable "cost pool" categories, many believed that some schools did not set a tone requiring responsible and ethical conduct in the use of public funds. Some schools voluntarily reimbursed the government for improper bills and others temporarily requested lower indirect costs rates. Stanford University President Donald Kennedy announced his resignation in July 1991, attributing his departure to the indirect cost controversy.

As a result of these alleged abuses, the changes OMB made on October 3, 1991 to Circular A-21 limit the items the government will accept as legitimately related to research and clarified unallowable indirect costs, including certain advertising and public relations, convocations related to instruction, alcoholic beverages, alumni activities, personal use of automobiles, some costs for litigation, donations and contributions by the institutions, some entertainment costs, employees' personal goods and housing expenses, some lobbying, and fees for memberships in social and country clubs and civic organizations. OMB also limited commercial air travel reimbursement to the cost of the lowest available discount airfares, prohibited charges for travel costs of trustees, required the collection of interest for unallowable costs, and required certification of the institution's indirect cost proposal by a high ranking official. (OMB. Revisions to Circular A-21, "Cost Principles for Educational Institutions." Federal Register, October 3, 1991, p. 50224 - 50233.)

In part as a response to the charges of abuse levied against Stanford, the Chief of Naval Research lowered Stanford's provisional indirect cost rate for 1991 to 55.5%, well below the 78% rate the school had proposed. Stanford subsequently requested an indirect cost rate of 76% for FY1992. It is estimated that this would cost Stanford over $30 million in reimbursements. Subsequently this rate was lowered to 60.31% for FY 1993. Some academics say that while there have been some abuses, the indirect cost rates system fundamentally was sound and that audits uncovered items that were not considered to be inappropriate when they were charged. Some allege that the government is retroactively applying new narrower auditing rules to prior billings. Many believe that cutting rates to compensate for prior alleged abuses would undermine the strength of U.S. academic research.

Also at issue was the legality of granting exemptions, by means of memoranda of understanding (MOUs), to some schools for costs not customarily allowed by Circular A-21 regulations. GAO testified that Stanford concluded about 90 MOUs with ONR which were not reviewed for propriety. These MOUs had the effect of raising Stanford's indirect costs rate from 54% to 74%. In contrast, the school with the second largest number of MOU exemptions was MIT, with between 8 and 13 MOUs.

In 1993 the Dept.of Justice announced it could find no evidence of fraud at Stanford, as did the Navy later. In October 1994, a settlement was reached and ONR dropped charges that the MOUs were invalid. Stanford agreed to repay $1.2 million to the government for accounting disputes (bringing the total repayment to $3 million, a small fraction of the Navy's original claim of $185 million in fradulent overcharges) and agreed to not appeal the lower indirect costs rates applied for 1991 and 1992. In 1996 a federal judge dismissed a suit against Stanford brought by Paul Biddle, a federal employee who had raised the original charges and sought under federal law to claim a portion of reclaimed money that had been fraudulently obtained.

Indirect Cost Rate Determination: Policy Debates

Equality of Rates Universities Charge Performers

The HHS Inspector General testified to the House Energy and Commerce Committee on May 9, 1991, that many schools charged the federal government higher indirect cost rates than they charge other research sponsors, including "foundations, public corporations, and foreign Governments. . . . Some schools waive the indirect cost rate, even for a million dollar contract with a publicly traded corporation. Schools with a federal indirect cost rate as high as 77% waive or reduce the rate with other entities to as little as 6 or 10%. . . . It appears clear. . .that schools may be looking to the Federal government to cover the overhead associated with research performed for non-federal and foreign entities." Among the 1991 revisions to Circular A-21 was language to "stipulate that the Federal Government will not in any way subsidize indirect costs of non-Federal research." (Federal Register. Oct. 3, 1991, p. 50227-50228.) CBO contends in its 1996 report on Reducing the Deficit, that large private universities still may charge lower overhead rates on private grants.

Some academics have suggested that indirect cost rates for universities be made comparable to rates the government negotiates in contracts with industry, which often exceed 100%, because industry includes more direct costs as indirect and includes more fringe benefits in indirect rate categories than do universities. (Overhead Obfuscation. Science. May 10, 1991, p. 767.) (Industrial research contracts calculate indirect cost rates on a cost-recovery principle. However, competitive bidding contains incentives to minimize costs, incentives that do not exist for university research.) A DHHS working group report, "Management of Research Costs: Indirect Costs," Fall 1992, proposed, among other things, that the government improve collection of data about indirect costs.

Lack of Uniformity in Accounting and Auditing; Proposals to Fix Rates

Attention has been directed to the differences in rates charged by schools and the lack of uniformity and consistency in determining the basis for calculating indirect cost rates. The House Science Committee in its report on H.R. 3322 called for the OSTP to develop options "to reduce the variation among indirect costs rates at different institutions." (H.Rept. 104-550, pt. 1, May 1, 1996.) One issue is the amount of federal cost sharing required by agencies since policies for cost recovery vary among agencies and even among programs within agencies. At the April 23, 1992, House Science and Technology Committee hearings, NSF Deputy Director Berenthal testified that while in principle NSF strives to provide full overhead recovery, cost sharing or participation is required in some NSF programs.

As a second issue, schools had been given considerable latitude to determine if a cost is direct or indirect, which promotes differences in indirect cost rate determination. For example, payments for such diverse items as department secretarial service or chemical waste disposal, which might be counted as direct costs at some schools, can be counted as indirect costs at other schools. To overcome this problem, institutions could have been required to shift more indirect costs to the direct costs budget line to enforce more rigid review and accountability. But such a requirement might alienate researchers from administrators because the financial interests and needs of the two groups differ and generally costs for overhead have been increasing faster than costs for research. OMB's 1991 revisions to Circular A-21 prohibited schools from shifting costs among indirect and direct rates and from administrative to other categories, but gave federal agencies some discretion to allow some shifts in conformance with normally accepted academic accounting practices. (56 Federal Register 50228, October 3, 1991.)

In July 1991, Stanford University announced that it would adopt accounting practices used by defense contractors, which encompass clear procedures to identify allowable costs and a code of ethics for employees. On June 4, 1991, the House Committee on Defense Appropriations report (H.Rept. 102-95) required all academic contracts and grants awarded by DOD to be audited in accordance with the Federal Acquisition Regulations (to promote comparability in audits made by DOD and HHS.)

The revisions made to Circular A-21 in May 1996 included requirements that all awards be governed by Cost Accounting Standards to achieve uniformity. Four standards are to be implemented specifically to develop uniform accounting, including consistency in estimating, accumulating, and reporting costs; consistency in allocating costs incurred for the same purpose; accounting for unallowable costs; and cost accounting period. Also the changes defined allowable "facilities and administrative" costs and eliminated the use of special cost studies to allocate utility, library and student services costs. Some universities object that these requirements are inflexible and will increase costs and the regulatory burden to universities. (New Rules for Recouping Overhead on Federal Research Put Uniformity Over Fairness, Says University Spokesman. Washington Fax, May 13, 1996.)

Some experts advocate fixed indirect cost rates for the indirect cost rate calculation. For instance, in H.Rept. 102-104, the House Appropriations Committee directed the HHS Inspector General to examine whether it would be cost-effective to return to a fixed indirect cost reimbursement rate (from 8% to 20%) that existed before 1966. The legislation passed both Houses, but was subsequently vetoed for other reasons. The enacted bill, H.R. 3839, which became P.L. 102-170 November 27, 1991, referred H.Rept. 102-104 as part of the law's legislative history.

Changes in Circular A-21; Other Proposals

Year-long deliberations between Administration and academic officials resulted in proposals to revise Circular A-21, which were discussed in the FY1996 budget (p. 99), proposed on February 6, 1995, (OMB. Proposed Revisions to OMB Circular A-21 and Proposed Rescission of OMB Circular A-88. Federal Register, February 6, 1995) and published revised in the Federal Register as final rules on May 8, 1996. In 1995, the Administration announced that any savings that would accrue from these changes would be reinvested in research. The revisions, among other things, incorporate four Cost Accounting Standards applicable to educational institutions; require certain large institutions to disclose their cost accounting practices by the submission of a Disclosure Statement prescribed by the Cost Accounting Standards Board; clarify the allowability of use and depreciation methodology; amend the definition of equipment by increasing the capitalization threshold; prohibit the use of "special studies" to determine utility, library and student services costs rates; require the same indirect cost rate to be used throughout the life of a grant; eliminate the allowability of employee dependent's tuition benefits; establish criteria for reimbursement of interest costs; eliminate ambiguity by requiring the use of the terms "facilities and administrative costs," instead of "indirect costs," eliminate Circular A-88 and establish cost negotiation responsibilities of cognizant agencies. These new rules had been scheduled to be published as final rules in April 1995, but were delayed until May 8, 1996, reportedly due to objections and additional study by an interagency task force, headed by OMB and OSTP, that reported in November 1995. In June 1995, OMB equalized federal requirements for equipment cost thresholds for capitalization, thereby reducing paperwork and administrative costs for academic institutions. (Federal Register, July 14, 1995.)

Previous revisions to Circular A-21 published on July 26, 1993, aggregated the seven "pools" of the overhead rate into two parts, administrative, with various caps, and facilities. The revisions shifted more direct and indirect costs to the administrative category, which is already capped at 26%, and gave schools the option of claiming an allowance fixed at 24% of modified total direct costs for the administrative portion of indirect costs, or a percentage equal to 95% of the most recently negotiated rate for administrative cost pools, whichever is less. If using the lower cap, schools would not be required to prepare the paperwork required to document rates. The revisions also attempted to ensure consistency by defining administrative and facilities components. The rules identified items to be included in direct and indirect cost pools to ensure consistency; the threshold rate for using a simplified method for computing indirect cost rates was raised to $10,000,000. (OMB. Cost Principles for Educational Institutions. Final Revisions to Circular A-21. Federal Register, v. 58, July 26, 1993, pp. 39996-39999.) OMB also recommended that study be continued to establish a government-wide database on indirect costs and that the government examine institutional differences in administrative costs and of alternatives to modified total direct cost to eliminate inconsistency among agencies in determining rates.

In a 1992 report prepared for the Subcommittee on Oversight and Investigations of the House Committee on Energy and Commerce, the GAO attributed excessive and unallowable billings to lack of adequate guidance in Circular A-21 for determining the allowability and allocability of specific costs, weak internal controls at universities, and inadequate agency oversight. It recommended that OMB "designate a single cognizant federal agency, using a consistent approach, to negotiate indirect cost rates," and that consideration be given to instituting a uniform flat rate or different flat rates for different categories of universities. (Federal Research, RCED-92-203, September 1992.) Both the GAO and the then majority staff of the House Government Operations Committee endorsed consideration of capping rates at 50% or at different maximum rates for different kinds of academic institutions. (Managing the Federal Government: a Decade of Decline, September 1992.) Responding to charges that it had not negotiated indirect cost rates equitably with all of its cognizant schools, the ONR announced in July 1992 that it would centralize control of negotiations by employing one team of experts to negotiate with the 44 schools for which it was responsible.

Facilities-related Indirect Costs

The facilities charge component of F&A rates is the fastest growing component of F&A reimbursements. CBO attributes this to increases in the costs of operating and maintaining facilities--utilities, repairs, and janitorial services-- despite the drop in energy prices. The latest available data show it increased from 36% of all academic indirect cost reimbursements in 1982 to 43% of the total in 1991, and according to OMB, caused reimbursements to increase over 70% in real dollar terms over the period 1982 to 1988. OMB also reported that differences in facilities costs explain much of the variation in indirect cost rates among schools. As a result, determining appropriate policy for facilities support is important to debates about lowering F&A cost rates. Some observers charge that schools with the most active facilities building programs have the highest F&A cost rates because they ". . . planned on the basis of rosetinted estimates of the size of the grant base on which indirect costs could be charged; and that grant base has not grown as fast as expected. (Barinaga, Marcia. Stanford Erupts Over Indirect Costs. Science, v. 248, April 20, 1990. p. 293.) Typically private schools have higher facilities related indirect cost rates because they lack state subsidies.

As an alternative to F&A costs, Congress has acted to support directly academic facilities renewal and construction. The Academic Facilities Modernization Act of 1988 (P.L. 100-570) authorized the NSF to award close to $1 billion in funding over 5 years for a competitive 50-50 matching grant program for university facilities restoration. Appropriations were $39 million for FY1990 and FY1991; President Bush did not request any funding for FY1992. (The Bush Administration reported that university facilities are supported via indirect costs and direct congressional earmarking of appropriations for facilities, which it opposed. OMB reported that $276 million was earmarked this way in FY1991 and $169 million in FY1992.) P.L. 102-139 appropriated $33 million for the NSF facilities and instrumentation program for FY1992, with $16.5 million for the facilities program. (The House-passed authorization act (H.R. 2282) allowed $40 million for FY1992 and $43 million for FY1993 for facilities.) The Administration sought to zero out the program for FY1993, but the Congress appropriated to NSF $37.5 million for facilities and $12.5 million for instrumentation (P.L. 102-389). For FY1994, P.L. 102-124 appropriated to NSF $110 million, split evenly between facilities and instrumentation, double the Administration request. For FY1995, NSF sought $55 million for both facilities and instrumentation; the Congress appropriated $250,000,000, allocating $118 million for facilities and instrumentation and $132 million for a new interagency facilities and instrumentation program. Congress stipulated that the funds would automatically be rescinded unless the Administration requested at least $250 million in FY1996 for NSF's infrastructure programs. Congress also requested the Administration to develop a 5-year interagency infrastructure program strategy (H.Rept. 103-715). The Administration requested only $100 million for the NSF program for FY1996. This was included in a rescission package enacted by the Congress (H.R. 1944, P.L. 104-19.) The Administration did not request any funds for academic facilities for NSF in FY1997; H.R. 3322, as passed in the House, authorized $100 million.

Also at issue is whether schools use facilities-related F&A reimbursements for facilities renewal. OMB's proposed revisions to Circular A-21 in June 1991, would have required schools to establish a dedicated fund for facilities-related indirect cost reimbursements to be used only for buildings and equipment supporting organized research. This would eliminate the practice of indirect cost recoveries reverting to state treasuries or to the general funds of institutions and not being used for facilities construction or repair. But OMB received many comments that academic institutions usually expend more for facilities than they receive in federal indirect costs reimbursements. The final October 1991 revision stipulated that institutions should give the government assurance that such reimbursements will be used for facilities costs. OMB stated that this requirement applies to the largest academic recipients of federal R&D funds, and specified 99 schools. (56 Federal Register, 50225, 50229, Oct. 3, 1991.) But some groups, notably the President's Council of Advisors on Science and Technology, in a December 1992 report (Renewing the Promise: Research-Intensive Universities and the Nation, p. 27), urged that universities be required to establish a set-aside fund to use facilities indirect cost reimbursements for facilities renewal.

OMB's 1995 proposed changes to Circular A-21 said that OMB was planning to develop "benchmarks" for facilities overhead costs which would determine reasonable costs for research facility construction and renovation that would be allowable; develop standard methods to calculate costs for specialized services, such as biohazards control and computational centers; develop standard benchmarks or rates for costs of utilities, libraries and student services; develop a model for charging "space " costs; revise the life schedule for equipment; and examine methods to explain variations in facilities and administrative costs rates. Press comments indicated that these changes probably would reduce indirect costs reimbursements for academic facilities and would be opposed. The OSTP prepared a report on this issue, but it has not been publicly released. In June 1995, a group of university administrators drafted a plan to dispense with negotiated costs rates, and to convert, over 10 years, to a fixed allowance for administrative costs and a formula-based allowance for facilities. Called the "Phoenix Plan," it would adjust facility costs by local differences in construction and utility costs, wage rates, and a "research mix" factor. Preliminary reactions to the draft indicate that savings would occur, but that large private research schools, with high indirect costs rates, were likely to oppose the proposal. (Washington Fax, Life Science, June 12, 1995). The changes to Circular A-21, published in May 1996, prohibit special studies to set rates and indicate that "benchmark studies to develop alternative payment methods for facility construction, utilities, and library costs are currently underway." The regulation also gives precise rules to transition from use allowance to depreciation calculation methods.

The Association of American Universities (AAU) had recommended two rates for indirect costs. One rate would be for facilities and equipment, accompanied by rules allowing faster depreciation of facilities. Another rate would be for administrative, library, and student services. This would be taken like a standard deduction. AAU also formally proposed to OMB that benchmarks be used to "determine what fraction of the cost of building construction and renovation could be charged to the government as part of research facilities costs." (Washington Fax, November 21, 1995.)

Administrative Costs

Administrative costs may be ambiguous, are often difficult to account for, and can vary significantly among institutions. Administrators say inflation has driven up costs of administrative components of indirect costs disproportionately in comparison with direct costs of research. In addition, some schools, have chosen to recover what they consider to be every allowable or "gray" cost of doing research, even though considered imprudent. October 1991 revisions to Circular A-21, OMB capped the amount that a university can claim for administrative indirect costs at 26% of the modified direct costs of a research grant and prohibited shifting costs from one account to another, from "indirect to direct or from administrative costs to other indirect costs." Exemptions are allowed if the institution's charging practices vary from practices followed by a substantial majority of other institutions. Before the cap, the average administrative cost was slightly higher, at about 27%, and ranged from 12% to 45%. In 1995, the Administration reported that the cap has saved about $110 million annually. ("Ideas on Costs of Research." White House Memo, Jan. 26, 1995.) The GAO reported savings of $104 million in 1993 due to the 26% administrative cap. (University Research: Effect of Indirect Costs Revisions and Options for Future Changes, GAO/RCED-95- 74.) CBO, in its 1996 report on Reducing the Deficit, attributes most of the reduced spending on administrative overhead to cut in support for libraries, which "may not be worth the lsos of future benefits to society as a whole."

Proposals for Caps and Pauses; Congressional Outlook

Interest rates and energy costs reimbursements in the 1980s helped to drive up average indirect costs rates from 30% of modified direct costs in 1970 to about 50% today. According to CBO, increases in the costs of operating and maintaining facilities -- utilities, repairs, and janitorial services --increased facilities costs components. (Reducing the Deficit: Spending and Revenue Options, February 1995.) In its July 1993 revisions to Circular A-21, OMB folded all non-facilities related indirect costs into the administrative category, which is capped at 26% of modified total direct costs. Schools can use that rate, a lower fixed rate of 24%, or a percentage equal to 95% of the most recently negotiated rate for cost pools under administration, whichever is less. If using the lower rate, they would not be required to prepare the paperwork required to document rates. Some student stipends would be treated as an overhead (administrative ) cost, a move which has drawn objections.

Various caps have been proposed on total indirect costs. OMB had proposed a 26% cap on indirect costs in 1986, when the government claimed it would save over $420 million on a $6.3 billion academic R&D budget. The NIH. . . estimated that the 26% cap would shave $50 million to $60 million per year from the total amount it pays for indirect costs -- enough to fund some 250 additional grants a year." (Palca, Joseph. OMB Tries on a New Cap. Science, v. 252, May 24, 1991. p. 1958.) OMB estimated that the cap would reduce total federal reimbursements by $80 million to $100 million a year. For several years, the CBO, in its annual reports, Reducing the Deficit: Spending and Revenue Options, has discussed options for reducing overhead rates on federally sponsored university research. For FY1997, as for several previous years, this includes freezing overhead payment rates at 90% of their 1996 level, which CBO estimates might save $2.1 billion over 1996-2002, if savings were not shifted to research funding. This option, according to CBO, would "hurt small and state universities that have kept their overhead costs low." NIH has recently discussed the issue of capping at 25% of direct costs, F&A costs for "bridge funding" for investigators whose research might not be funding because their competing continuation grants applications fall just a few percentile points beyond NIH's funding range. Spokespeople for the Council on Governmental Relations (COGR) and the Association of American Universities contend that schools should choose the form of cost-sharing that is best for them and that NIH grantees would unfairly benefit from the F&A costs paid by other federal agencies for research if their F&A rates were capped. (Washington Fax, Life Science, November 21, 1996 and December 10, 1996.)

In the 103rd Congress, legislation was introduced, but not enacted, to cap indirect costs rates at the current average of 50% (H.R. 3958, S. 1184, S. 2105). The pros and cons of such caps were discussed by GAO in System for Reimbursing Universities' Indirect Costs Should be Reevaluated, 1992, and by a staff study of the House Committee on Government Operations, Managing the Federal Government; A Decade of Decline, 1992. In 1993, President Clinton proposed cutting overhead reimbursements paid by agencies by $1.2 billion over the next 4 years. (OMB. A Vision of Change for America, February 17, 1993.) No firm budget proposals were introduced. One news article conjectured that Clinton would propose to cap administrative costs at 22%, which he did not do. (Anderson, Christopher. Clinton's Technology Policy Emerges. Science, February 26, 1993, p. 1245.) Some university administrators translated this into an effective overall cap of 44% for indirect costs.

The President's FY1995 budget proposed a one-year "pause," relative to FY1994, on overhead payments for research at universities and other nonprofit institutions receiving more than $10 million annually in federal research funds. (This was also included in H.Con.Res. 218.) Two reasons were given: (1) since total discretionary spending was being frozen, universities need to participate in spending restraints; and (2) the "pause will provide time for the Council of Economic Advisers, the Office of Science and Technology Policy, and the Office of Management and Budget -- with advice from representatives of affected institutions -- to conduct a comprehensive review with the goal of improving the incentives that govern overhead reimbursement . . . ." (Budget of the U.S. Government, Fiscal Year 1995, p. 117.) The study was completed; and the GAO surveyed a sample of major universities to determine the effects of the latest changes in Circular A-21. The Administration held a conference on indirect costs policy on May 23, 1994. The HHS Secretary said the Administration wanted to see savings made in administrative costs, rather than in research. Cornelius Pings, president of the AAU, told Administration officials that the pause plan was "bad science policy, bad public policy, and flawed budgeting" and that the freeze would prompt legal action since it would break existing agreements. Reportedly, an OMB analysis said that proposed pause would have saved $150 million for FY1995. The CBO concluded that savings would not accrue until FY1996. (Washington Fax. Life Science, April 29, 1994.)

The Administration sought to incorporate the pause individually into each appropriations bill for FY1995, an approach which was rejected. The House concurrent resolution on the budget for FY1995 (H.Rept. 103-428 on H.Con.Res. 218) assumed the pause and estimated savings at $130 million for FY1995; the Senate concurrent budget resolution opposed the pause (S.Rept. 103-238 on S.Con.Res. 63). Conferees rejected the pause in the Conference report (H.Rept. 103-490). The pause, applicable only to NSF grants, was included in the NSF Authorization Act of 1994, H.R. 3254, which passed the House, but not in the Senate version, S. 2344, which was reported but did not see floor action. The Administration and the NSF opposed the indirect cost pause provision in H.R. 3254. The National Science Board endorsed a resolution opposing the pause. Some academic opponents said the pause would unduly penalize only those (smaller) institutions that increased their research portfolios.

The VA/HUD/Independent Agencies appropriations bill, FY1995, P.L. 103-327, prohibited the pause, because, as noted in the House and Senate reports, the Administration was studying the issue and changes had been made in Circular A-21 in 1993. The Labor/HHS appropriations subcommittee did not include the pause in its report on the FY1995 bill, because the proposal did not "address key underlying problems such as the disparity in indirect cost rates among institutions." It expressed concern about the rising share of Federal R&D funds to academia for indirect costs and asked the Administration to revise the allocation. (H.Rept. 102-553, p. 67.) The conference report (H.Rept. 103-747), on H.R. 4650, the DOD appropriations bill, which was enacted and signed as P.L. 103-335, linked the $200-million cut it made in funding for university research to its concerns about the alleged $500 million in overhead the DOD pays annually and the variability in indirect costs rates among schools. The Secretary of Defense was ordered to report by February 1, 1995 on actions he would take to address these concerns.

In 1994, the FY1995 Republican Budget Initiative (Kasich Budget) proposed to freeze the payment rates for academic overhead at 90% of their then current levels. (H.Rept. 103-428.) The House Budget Committee's Republican staff analysis of "Possible Offsets for the Contract With America," proposed reducing overhead rates for federally sponsored university research by $1.620 billion over 5 years. The 104th Congress's enacted appropriations generally fund research at or slightly below current levels in real dollar terms. Thus, in order to maintain the same number of academic research grants, agencies might seek to reduce F&A costs reimbursements. Reportedly, Senator Domenici considered a reduction in overhead payments as part of a package of amendments to the budget resolution. (Washington Fax, Life Science. May 3, 1995, p. 2.) A balanced budget bill, H.R. 1923, would have essentially reduced indirect cost rates payments to 90% of the FY1995 levels. S. 999, in the 104th Congress, among other things, would have reduced the indirect costs rate to 50% of modified total direct costs. Also, a prohibition on caps, except as published in Circular A-21, was included in H.R. 2099, the VA/HUD/Independent Agencies Appropriations Act, as enrolled but vetoed by the President, and in H.R. 3666, a similar enacted appropriations bill for FY1997, P.L. 104-204. The House Science Committee in the NSF authorization bill (H.R. 1852, H.Rept. 104-231, August 4, 1995), required the OSTP to determine how the indirect costs of research could be reduced by 10% and how to reduce the variance in rates among different institutions. This language was in H.R. 2405, the Omnibus Civilian Science Authorization Act, passed by the House in 1995, and in H.R. 3322, the Omnibus Civilian Science Act of FY1997 (not enacted). Report language for H.R. 2127, the FY1996 HHS Appropriations bill (S.Rept. 104-145 and H.Rept. 104-209), reflected concern about the high amounts of indirect costs reimbursements for NIH grantees and complimented current efforts underway to lower rates (Phoenix Plan, OMB proposed changes to Circular A-21, and so forth). GAO, in July 1995, initiated a study for Representatives Porter and Miller, of the House Appropriations Committee, to assess the regulatory costs of research supported by NIH (as part of the way to reduce indirect costs of federally funded research.) In May of 1996, GAO issued a letter report concluding the study due to difficulties in obtaining information about these costs.

Universities protest caps, saying that it is difficult to be more efficient and that they would have to bear the non-allowable costs if caps were instituted and that ceilings are inequitable since schools use different cost accounting procedures. They say that the government needs to pay its full share for the conduct of research and not require schools to use student tuition to support research. GAO discussed this issue in: Higher Education: Tuition Increasing Faster Than Household Income and Public Colleges" Costs," August 1996. Some argue that caps would cause universities to slowly decay, for instance by cutting back on library collections, which, in the long run, could jeopardize the quality of American research and science education, and which CBO says has already occurred as part of efforts to lower administrative costs. (See also Renewing the Promise: Research-Intensive Universities and the Nation, p. xvi.) Some say that unnecessary regulations drive up costs, and should be eliminated. In July 1992, the Council on Governmental Relations and the AAU released a joint study prepared for the OSTP on the cost of federal research paid for by universities. It concluded that most universities collected "considerably less" in indirect costs reimbursements than their total overhead costs for the conduct of the research.

Other Options to Lower Rates

The GAO, in a March 1995 report, University Research: Effect of Indirect Cost Revisions and Options for Future Changes, proposed other cost-cutting options, such as: flat rates; freezing the negotiated administrative costs rate allowable without documentation; using standard deduction rates for utility and library costs; revising use allowances to reflect actual equipment lifetimes; modifying methods to claim interest on debt for new research facilities; imposing a ceiling on the costs of improvements for the year incurred; and requiring institutions to use Circular A-21's simplified method to calculate indirect costs. In congressional testimony, the HHS Inspector General identified other options, including the following:

--Award block grants to universities and let them decide what research to conduct and how costs should be divided between direct and indirect costs.

--Award research dollars to principal investigators, who would have to negotiate indirect cost components with school administrators.

--Mandate more cost sharing for research.

--Limit indirect costs only to add-on costs incurred in conducting research (not paying for overhead costs that would have been incurred even if research were not conducted).

--Eliminate government-wide rates and allow granting agencies to negotiate separate indirect cost rates for their programs (so that indirect cost rates would be higher for some kinds of research).

Consideration might also be given to refining the Federal Demonstration Project (FDP). To cut paperwork costs, in May 1986, five federal agencies and several universities in Florida began the Florida Demonstration Project which was designed, in part, to see if there were effective time saving ways of documenting accountability in the distribution of research grant money. In March 1988, the Presidential Task Force on Regulatory Relief approved an expansion beyond Florida. OMB and OSTP manage this activity. In 1994, the National Performance Review. Major Recommendations By Agency of From Red Tape to Results, Appendix A, recommended expansion of the FDP.

Indirect Cost Rates for Other Performers

Questions have been raised about the F&A cost rates and recoveries allowed to federal laboratories (funded by DOD and the Department of Energy), other nonprofit institutions such as the National Academy of Sciences complex, and industry. CBO in 1995, reported that NIH's 1994 rates for universities, at 51%, are lower than its rates for research institutes at 63%; hospitals, 57%; and for-profits, 56%. Reportedly, some private corporations' indirect cost rates have reached 100% because many more costs of conducting research are listed as indirect, rather than direct costs. Questions have been asked about the rates charged by federal laboratories, which have reported rates about half the rate charged by universities. Some speculate that laboratories' rates are based on artificially high modified direct costs, with true indirect costs rates reaching as high as 150% in some cases. (Overhead Question, Science, May 10, 1991, p. 767.) The allegation is that the more costs are defined as indirect rather than direct, the less oversight federal government managers have over research activities and the easier it is for abuses to occur. Furthermore, the higher the ratio of indirect to direct costs, the lower the amount of direct funding that goes for research. The Senate Committee on Governmental Affairs released a report in July 1992, entitled Inadequate Federal Oversight of Federally Funded Research and Development Centers, which recommended that federal agencies reevaluate their cost policies and controls for federal laboratories. (Final Indirect-Cost Rule Satisfies Few. Science, June 14, 1996.)


CONGRESSIONAL HEARINGS, REPORTS, AND DOCUMENTS

U.S. Congress. House. Committee on Energy and Commerce. Subcommittee on Oversight and Investigations. Financial responsibility at universities. Hearings, Mar. 13 and May 9, 1991. Washington, U.S. Govt. Print. Off., 1991. 420 p.

U.S. Congress. House. Committee on Science, Space and Technology. Subcommittee on Science. Indirect cost of university research. Hearings held April 1991. 102nd Congress, lst session. Washington, U.S. Govt. Print. Off., 1991. 297p.

CRS Report

CRS Report 94-646. Indirect costs for R&D at higher education institutions: Annotated chronology of major federal policies.