Introduction

Overview of Facilities and Administrative Costs

Introduction

1.An analysis of the federal indirect cost reimbursement rates (as the term is defined in Office of Management and Budget Circular A-21) paid to universities in comparison with federal indirect cost reimbursement rates paid to other entities, such as industry, government laboratories, research hospitals, and nonprofit institutions.

2.An analysis of the distribution of the federal indirect costs reimbursement rates by category (such as administration, facilities, utilities, and libraries) and by the type of entity; and determine what factors, including the type of research, influence the distribution.

3.An analysis of the impact, if any, that changes in Office of Management and Budget Circular A-21 have had on the federal indirect cost reimbursement rates, the rate of change of the federal indirect cost reimbursement rates, the distribution by category of the federal indirect cost reimbursement rates, and the distribution by type of entity of the federal indirect cost reimbursement rates; and the federal indirect cost reimbursement (as calculated in accordance with Office of Management and Budget Circular A-21), the rate of change of the federal indirect cost reimbursement, the distribution by category of the federal indirect cost reimbursement, and the distribution by type of entity of the federal indirect cost reimbursement.

4.An analysis of the impact, if any, of federal and state law on the federal indirect cost reimbursement rates.

5.An analysis of options to reduce or control the rate of growth of the federal indirect cost reimbursement rates, including such options as benchmarking of facilities and equipment cost, elimination of cost studies, and mandated percentage reductions in the federal indirect cost reimbursement, and assess the benefits and burdens of the options to the federal government, research institutions, and researchers.

6.An analysis of options for creating a database that would serve two functions; tracking the federal indirect cost reimbursement rates and the federal indirect cost reimbursement and supporting analysis of the impact that changes in policies with respect to federal indirect costs reimbursement and supporting analysis of the impact that changes in policies with respect to federal indirect cost reimbursement will have on the federal government, researchers, and research institutions.

This report addresses these six issues.In conducting our analysis, OSTP used input from the RAND report, Paying for University Research Facilities and Administration; data provided by the Council on Governmental Relations; discussions and data provided by a small group of public and private research universities; discussions with OMB and federal agencies; and other published reports. 

 
Overview of Facilities and Administrative Costs

Determining the F&A Rate¹

The F&A rate is determined by dividing the facilities and administrative costs by the Modified Total Direct Costs (MTDC). Modified Total Direct Costs is equal to direct costs minus exclusions (such as equipment and subcontracts).MTDC is considered the accepted base for allocating F&A costs because these costs are thought to be a reasonable indicator of how much benefit the project derives from the shared facilities and administration.Because subcontracts and equipment can involve very large expenditures and yet do not necessarily take advantage of a university's infrastructure, they are excluded from MTDC when calculating the base. 

A university's F&A rate is computed by dividing its F&A costs by its MTDC. F&A rates of about 50 percent of MTDC are typical of universities.A common misunderstanding is that a 50 percent F&A rate means that 50 percent of total expenditures are for overhead.This is not the case.Because the F&A rate is the ratio of F&A costs to MTDC (rather than total costs), F&A costs may account for only one quarter of total costs, when the F&A rate is 50 percent.

If there are no exclusions from direct costs (such as equipment and subcontracts) then all costs are either MTDC or F&A costs.In this case, a typical 50 percent F&A rate would mean that for each $100 in MTDC, $50 in F&A costs would be allocated.The $50 in F&A costs out of a total budget of $150 means that one-third of project costs are F&A costs in this example.

F&A rates are established through negotiations between the federal government and individual institutions.The established rates are used to bill the federal government for the F&A cost portion of federal programs, when not restricted by program statutes or agency policies. 

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¹ This section borrows from Paying for University Research Facilities and Administration, RAND, 2000, P. 14.

Our analysis of the six major issues raised in the NSF Authorization Act of 1998 (Public Law 105-207) follows: 

Issue One: Comparison of F&A Rates across Sectors

Data collected from this small group of institutions demonstrates how a university may have an effective F&A rate that is lower than its negotiated F&A rate.For example, a private university X has a negotiated rate of 48%.However, because of various policies it has an effective rate of approximately 44%, meaning that it doesn't recover indirect costs at the 48% level. As Table 1 indicates, university X has different rates from most of the federal agencies.This is due to federal policy, either dictated by statute or by agency practice, and institutional policies. 

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² Arthur Andersen, LLP, “The Costs of Research: Examining Patterns of Expenditures Across Research Sectors,” prepared for the Government-University-Industry Research Roundtable of the National Academy of Sciences, National Academy of Engineering, and the Institute of Medicine, Chicago, Ill., March 1996.

³ RAND, pp. 33-44.

⁴ RAND, p. 33.

Another university, public university Y shows a similar pattern. (Table 2.)  Its negotiated rate is 37.06%.Yet, its effective rate is approximately 30% due to policies of the federal government, stategovernments, and the university itself.

Federal Policies and Practices

1.Most USDA project grants are limited by statute to 14% of total costs for facilities and administration.In addition, land grant colleges and universities often undertake cooperative agreements at 0% F&A cost reimbursement. 

2.NIH agency policy caps Training Grants at 8% F&A cost reimbursement.

3.Many international programs from USAID and other federal programs do not allow F&A costs.

Institutional Policies

4.Quite often a university will waive F&A cost reimbursement for Young/New Investigator Awards in order to maximize the start-up funds provided to the scientist.

5.Some universities meet the NSF 1% statutory cost-sharing requirement through reductions in reimbursements for indirect costs.

6.Sometimes a university may agree to lower F&A rates on some federal research projects because of perceived pressure from agency program officers.If the research is of paramount importance to the university, it may accept the award without full recovery.

State Policies

7.In many states, indirect costs recovery does not stay at the university, but rather is passed through to the state.In these cases, universities may not pursue full recovery.

To determine the degree to which the universities are assuming some of the F&A costs of performing government-sponsored research, we analyzed public data from the Council on Governmental Relations (COGR), which conducts an informal annual survey regarding F&A costs of its member institutions (which includes most major research-intensive universities).The results of this analysis suggest that the difference between institutions negotiated rates and their effective recovery rates equals approximately $0.6 billion.This could be construed as $0.6 billion of F&A costs that are not recovered annually.⁵ While the COGR data are incomplete and some discrepancies do exist, this estimate provides some indication that the universities pay for some of the F&A costs due to a variety of federal, state, and institutional policies and practices as discussed above.It suggests that, of the $5 billion that universities report they devote to research from their own funds, approximately $0.6 billion is the result of facilities and administrative costs, that for a variety of reasons, the Federal Government does not pay. 
 

Issue Three: Impact of Changes in Circular A-21.
 

During the 1990s, as results of Congressional and public concerns regarding indirect costs at universities, OMB implemented a number of changes in Circular A-21, “Cost Principles for Educational Institutions,” to limit the payment of certain costs, to provide clarification for consistent treatment of other costs, and to simplify some administrative procedures.These recent changes have, or may have had, an influence on negotiated F&A rates.These include the cap on administrative rates, the change in the equipment threshold, and the establishment of a fixed utility cost adjustment rate component.According to the RAND analysis,⁶ the effects of these changes are: 

·During 1993, the first full year the administrative cap was in effect, negotiated administrative rates were reduced by approximately 2 percent; since that time, administrative rates have remained constant;

·Library rates have remained constant since 1988;

·Depreciation/Use allowance rates for buildings and equipment have increased gradually from nearly 6 percent in 1988 to approximately 9 percent in 1999, although some of the increase has been offset by reductions in operations and maintenance rates;

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⁵ RAND's report also relied on data from the COGR survey. RAND estimates the F&A costs not recovered at $0.8 billion. Unlike the RAND analysis, we did not assume that the MTDC is an independent variable. Rather, we assume that the total Federal budget line is the independent variable. Using the COGR data, this assumption yields estimated F&A costs not recovered at $0.6 billion. RAND, pp. 18-20.

⁶ For a discussion and analysis of these changes see RAND, 2000, pp. 45-51.

·The magnitude of the effect of the change in the equipment threshold is not known, but it is expected to produce savings for both universities and the government because it reduces the need to track small items or equipment;

·Although the precise effect of the utility cost adjustment is not yet known, it is unlikely to have a significant impact.
 

Issue Four: Impact of Federal and State Law on F&A Rates. 
 

In addition to the administrative requirements mandated by OMB Circulars, the universities must also satisfy other federal, state and local laws, and regulations regarding the conduct of research.These laws and regulations govern university practices in many areas including hazardous waste, occupational safety, animal care, and the protection of human subjects. While these laws and regulations have been enacted for worthwhile purposes, they have very real administrative costs associated with them.

Universities currently below the 26% cap on administrative costs would be paid for any costs associated with implementing these laws and regulations for federal research awards.Those universities that have F&A expenses at, or above, the cap would not be paid for any additional costs above the cap, including costs resulting from new requirement.Consequently, new law and regulations may require that some universities provide additional resources. 
 

Issue Five: Options to Reduce or Control the Rate of Growth of Federal F&A Reimbursement Rates.
 

In recent years, Circular A-21 has been revised to incorporate numerous measures to contain F&A costs, promote efficiency, improve equity, and minimize unexplained variations in rates across institutions.(See appendix A for a detailed description of each of these revisions.) The General Accounting Office estimated that the revisions to establish an administrative cap in 1991 resulted in an annual saving of $104 million.⁷

Other revisions have streamlined and improved the consistency of the F&A rate determination process, and have reduced the variances of rates between institutions.Federal agencies use F&A savings to fund more research projects.These recent revisions have increased accountability in the indirect cost system, and have responded to concerns raised by Congress and others about the need to ensure the appropriateness of federal payments for indirect costs.

There are other options to reduce federal F&A payments.(Appendix B) These options are grouped into four categories, according to the means by which they could reduce indirect cost payments.Most of these options have been considered previously. Few of these options have been implemented because the benefits derived from them may not be greater than the administrative burden that would be placed upon the Federal government or universities.

While some of these options would reduce federal payments for indirect costs, in many cases, these costs would simply be shifted to universities. The consequences of such shifting are likely to be reductions in total support for research, reductions in total funds spent by universities on other aspects of education, or tuition increases.Any potential savings achieved by reducing federal indirect cost payments would not be realized unless specific federal appropriations were reduced to reflect savings in indirect costs.Alternatively, if savings were achieved, these resources could be redirected to fund additional research grants, as they have been in the past.

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⁷ GAO Report RCED 95-74, University Research, Effect of Indirect Costs Revisions and Options for Future Changes, 3/95.
 

Issue Six: Options for Creating an F&A Database.

While there are some existing database systems that capture some F&A data, there is no systematic method by which the federal government collects and maintains data on F&A rates and costs.Because of the importance of the issues associated with F&A rates and costs, a central database of federal research F&A costs should be created and maintained that could 1) track the federal indirect cost reimbursement rates and the federal indirect cost reimbursement, 2) provide analysis of the impact that changes in policies would have on indirect costs, and 3) provide analysis of the impact that changes in policies regarding indirect costs would have on the federal government, researchers, and research institutions.Creating such a database would require an organization within the government to take responsibility for collecting and analyzing these data.Data could, for example, be collected from the standardized F&A proposal format that OMB and the agencies are developing with assistance from university representatives.The standard format will be added to Circular A-21.This standard format will streamline the F&A rate proposal preparation and review process and facilitate the federal government's collection of useful F&A data for analysis purposes. 
 
 

Based on our analysis, we have reached the following conclusions: 

1.Facilities and Administrative costs (judged by negotiated F&A rates) as a percentage of project costs have remained steady during the past decade. 

2.While Federal policy could be enacted to further reduce F&A rates, we believe that increased pressure on universities to provide additional cost sharing would be detrimental to the research enterprise.It may have an impact on university spending for both research and education, or it could increased tuition rates.

3.F&A rates at colleges and universities are slightly lower than those at other types of research institutions, such as federal laboratories and industrial facilities.

4.Universities are paying for a portion of facilities and administration costs that are eligible for reimbursement based on their negotiated F&A rates, as a result of federal statutes, agency policy, state policies, and internal university policies and practices. 

5.A database for federal research F&A data should be created and maintained.A standard format for F&A rate proposal submission has been developed for this purpose.

The Federal Government's investment in academic research is critical to continued economic progress for our nation.Our research funding to universities continues to increase from $11.7 billion in 1993 to $17.8 billion in the FY 2001 President's Budget (an increase of 53 percent).Our analysis, as well as RAND's, indicates that universities are contributing in a significant way to making this investment strong.For this reason, we caution against imposing significant additional costs on research-performing institutions. 

Pressure to increase cost-sharing through decreases in F&A recovery, for example, could result in reduced investments in building and renovating scientific facilities, thus jeopardizing future research capability. The federal government should work with universities to insure that appropriate investments in research facilities, instrumentation, and equipment are made.These investments have helped increase the productivity of modern research, and can be expected to further enhance the ability of research faculty to make important scientific and technical breakthroughs in the future.
 
 

Revisions to OMB Circular A-21 Effecting F&A Costs

5.Benchmarking of Facilities.In 1998, Circular A-21was revised to establish review and documentation requirements to ensure the reasonableness of the costs of large research facilities. For all new facilities projects that exceed $25 million, and in which at least 50% of the space is allocated to federally-sponsored research, universities are required to present justification documentation to negotiators, including an analysis of the costs and a comparison of those costs to relevant construction cost data.The benchmarks are based on data the National Science Foundation collects biennially and other relevant construction data.In addition, the 1998 revision provided that an institution's cost management process would be reviewed annually for adequacy under OMB Circular A-133 audits for federal programs.

6.Study Direct Charging of Space Costs.In 1995, the Federal Demonstration Project (FDP) studied the feasibility of direct charging space costs to research grants. The study provides a range of models that might be used to direct charge space costs.The FDP's evaluation and assessment of these models, however, led them to conclude that the administrative costs and organizational disruptions associated with implementation of a system of direct charging facilities costs would exceed any efficiencies that might be gained.Accordingly, the FDP recommended against the development or testing of direct charged facilities costs in order to bring these costs to the peer review process.

7.Depreciation and Use Allowance.A revision to Circular A-21 in 1996 clarified that, in the case where an educational institution, by its own choice, elects to convert from the use allowance to the depreciation method, the conversion should be made as if the depreciation method had been used over the entire life of the asset.In addition, use allowance recoveries are limited to the acquisition cost of the building, or the fair market value of the donated building.Institutions that report depreciation on their financial statements are required to use the same depreciation method and useful lives.

8.Develop a Standard Format for the Submission of F&A Proposals.OMB, with assistance from federal agencies and universities, developed a standard format for the submission of F&A cost proposals to assist universities in completing their F&A rate proposals more efficiently and to help federal cognizant agencies review each proposal on a more consistent basis.OMB is expecting to add the standard format in OMB Circular A-21 shortly. 

9.Change the Method of Calculating F&A for Smaller Institutions.A 1993 revision allows universities that use the simplified method to calculate F&A rates (i.e., by grouping all the costs in one pool and then dividing by the direct costs) to use either salaries and wages or MTDC as a base to distribute their F&A costs. This change provides more comparability of rates between small (defined as having less than $10 million in total federal direct costs) and large universities.

10.Capitalization Threshold for Equipment.In 1996, the threshold for capitalizing equipment was raised from $500 to $5,000 (or the institution's own selected capitalization threshold for its owns accounting records, if lower) thereby reducing paperwork and administrative costs for academic institutions.

11.Cost Accounting Standards Board (CASB) Standards.A 1996 revision to Circular A-21 included requirements that all awards be governed by Cost Accounting Standards (CAS) to achieve uniformity.Four standards were to be implemented to develop uniform accounting practices, including consistency in: estimating, accumulating, and reporting costs; allocating costs incurred for the same purpose; accounting for unallowable costs; and the definition of the cost accounting period (i.e., fiscal year, calendar year).Larger institutions were required to disclose their cost accounting practices by submitting a Disclosure Statement prescribed by the CASB.Small institutions with less than $25 million in federal funding are subject to the CAS, but are exempt from the Disclosure Statement filing requirements.

Options to Reduce F&A Costs

Burdens:These options could also limit federal payments for legitimate F&A costs that, in some cases, could then simply be shifted to universities.This cost-shifting could potentially affect the quality of research, and could, for example, cause universities to delay needed renovations and construction of facilities if they are no longer reimbursed for the interest costs associated with these projects.These options could also reverse the Federal government long standing policy regarding the allowability of these cost items.

Group B: Establish Caps or Flat Rates for Specific Costs

This set of options would establish new rate limitations for specific types of indirect costs and/or reduce current rates by a pre-determined level.For example, one option could be to establish a cap on Facilities costs (e.g., 25 percent), comparable to the cap on Administrative costs.This would have the effect of establishing a maximum total F&A rate for all universities (e.g., 51 percent).There is some precedent for this approach: some federal agencies currently pay a maximum indirect cost rate, either through appropriations language (e.g., USDA programs) or through grant proposal requirements (e.g., NIH training grants).As indicated above, exercising this option is likely to hinder the universities' performance of research and education of students in critical areas involving toxic materials, such as semiconductor processing and molecular biology.

Similarly, an alternative could be to establish a permanent university-specific rate for total F&A costs based on some historical measure (e.g., a 5-year average).Other options include freezing all F&A rates at their current levels; reducing F&A rates across the board by a fixed percentage over a period of time to achieve a predetermined level of savings, e.g., a 10 percent reduction over 5 years; or allowing schools to receive 90 percent of current negotiated rates without submission of a F&A proposal.

Benefits:Any limit on or reduction to F&A rates would reduce federal indirect cost payments directly.For example, assuming all other factors remain unchanged, a one percent reduction in the average indirect cost rate would produce $100 million in savings in F&A reimbursement.However, the savings could not be realized without decreasing the budgets for federal agencies supporting university research, including the National Science Foundation and the National Institutes of Health.

Burdens: These options could create disincentives for universities to invest in research infrastructure and support.Furthermore, these options could generate wholesale changes to the method by which the federal government supports F&A costs at a time when there is no clear evidence that the system requires major restructuring.The wholesale changes could include establishment of a national flat F&A rate, the awarding of projects based on total costs, or a requirement for cost sharing in the F&A costs.These changes would alter the federal government policy as stated OMB Circular A-21 to “bear its fair share of fair share of the total costs” for research and reduce the government's role in supporting the nation's research enterprise.The options could also lead universities to change their cost accounting practices to direct charge more of their costs, thus increasing the administrative burden for accounting and reducing efficiency.

Group C: Eliminate or Restrict Special Studies

This set of options would further address current Circular A-21 policy on special studies.One option could be to lower or eliminate the Utility Cost Adjustment (UCA) below the current 1.3 percentage points rate.Another option would be to eliminate Special Studies for Libraries, which are used by a few universities to claim library costs above the standard allocation method.In 1995, OMB proposed to eliminate special studies for libraries, based on evidence that the studies were biased.However, due to the uncertain effects of changes to university libraries and their services that have been brought about by the increased use of the Internet and on-line research, OMB deferred its decision to eliminate special studies for libraries pending further evaluation of the impact of these changes on the costs of library services benefiting research.An additional option related to libraries could be to include library costs under the administrative cap.

Benefits: These options would simplify the F&A rate negotiation process by eliminating universities incentive to conduct complex and expensive special studies and the federal government's need to review and monitor these studies.Any changes to allowable costs under Circular A-21 could achieve savings for the federal government, particularly for universities already at the 26 percent cap.

Burdens: These options, in particular the library options, could shift allowable and legitimate costs to the universities.In addition, these options could disrupt the implementation of the UCA, which was put into effect only in 1996.

Group D: Promote Efficiency by Simplifying the Process and Creating Incentives

This set of options would simplify the complicated process that is undertaken when the federal government negotiates indirect cost rates with universities.One option for simplification would be to encourage universities and agencies to extend current rates (e.g., from 3 to 5 years).Rather than periodically reviewing rates, as is the current practice, F&A rates would only be re-negotiated if an institution could document a significant change in its F&A costs.This option would promote stability in F&A payments for both the federal government and universities.Another option would be to allow schools to use 90% of current negotiated rates without submission of a F&A proposal when there are no material increases in the institution's organized research base.

Benefits: The primary benefits of these options would be simplification of a complex process that can be adversarial as the federal government and institutions routinely negotiate F&A rates.

Burdens: Like many of the options in Group B, these options could generate changes to the method by which the federal government supports F&A costs at a time when there is no clear evidence that the system requires major restructuring.