The Economics of University Indirect Cost Reimbursement in Federal Research Grants

The federal government has been the most important source of funds for academic research since the 1950s. Nearly a third of this support takes the form of indirect cost recovery (overhead). Long a source of conflict between universities and the government, in recent years the indirect cost controversy has escalated, with most research universities intensively investigated for alleged abuses. This essay examines the nature of indirect costs and the sources of the conflicts about them. The main argument is that the types of costs that are covered by overhead charges must be paid for the research intensity of universities to be retained; however, the existing system for reimbursing these costs creates unnecessary distortions in the operation of universities and has very high transactions costs. Instead, both universities and the federal government would be better off if the existing indirect cost reimbursement system were replaced by a system of fixed reimbursement rates that were not related to a university's actual indirect costs.