the cost of the desired effort can be measured in advance with reasonable accuracy and where the work will be performed over a relatively short period of time by educational or other nonprofit organizations, a grant may be used in lieu of a contract. "It is the need for administrative control and scientific direction as well as the nature of the work which governs the selection of the administrative vehicle used. Grants and contracts are frequently performed side by side the same personnel and in the same laboratory areas. "It is the policy of the DOD to pay all applicable costs irrespective of the type of vehicle used to obtain performance of the desired research except for those cases where it is fully understood and agreed to by both parties that cost sharing is desirable. As will be discussed later on, the applicable costs are determined by considering both the direct and indirect costs under the individual circumstances. Therefore, these costs will vary from institution to institution. Under these circumstances, the Department of Defense most strongly believes that flat indirect cost rates would have the effect of distorting the cost base or would force mandatory cost sharing across the board, and would not be in the best interest of the long-range scientific development program. Cost sharing on a selective basis is highly desirable when the results of work performed provide some special benefit to the contractor, or is otherwise equitable to both parties. On this matter, the General Accounting Office has made the following observations: "We concur in the basic policy that in supporting research conducted in institutions of higher learning, agencies of the Federal Government if requested, should reimburse these institutions for the indirect costs associated with the direct cost of research supported. We believe that the agencies, within the broad policy and guidelines established governing the programs conducted by them, should determine the avenues of research to be pursued at their expense and believe it only fair that all cost of such research be a proper charge to the activities so conducted, except, of course, to the extent others are interested in such research and equitable arrangements for a sharing of the cost can be agreed upon.' "The concept of a mandatory flat overhead rate limitation overlooks the fundamental cost accounting principle that there is no real difference between direct and indirect costs, except for the manner in which they are allocated to the work benefited by their incurrence. The costs of the material directly used in the work and the salaries of people directly employed on the work can be clearly and readily identified and classified as direct costs. Other materials and labor costs serving some general support purpose are not readily identifiable directly with the work but can be reasonably prorated as indirect costs. Both types of costs (direct and indirect) are made up of such elements as salaries and wages, materials, supplies, and services. A dollar of indirect cost is exactly equal to a dollar of direct cost in terms of outlay. The man who fires the furnace that heats the laboratory in which the researcher performs his work contributes in his way to the research just as surely as does the researcher himself. In "There are no hard and fast rules governing the division of total costs between those to be treated as direct costs and those to be treated as indirect costs. Consequently, the total costs of a contractor with a high overhead rate could very well be less than the total costs of a contractor with a low overhead rate. the absence of an artificial stimulus such as a mandatory, fixed overhead rate limitation, the logical and economical division of total costs is a matter dependent on such factors as how the contractor is organized, the nature of his business, how he keeps his books and whether the costs were specifically incurred for a particular purpose such as the performance of a contract or grant or whether they were incurred for common or joint objectives not readily subject to treatment as direct costs of a contract or grant or other activities. "In the case of educational institutions, the Department of Defense follows the policy of measuring the costs of its grants and contracts in accordance with the cost principles issued for that purpose by the Bureau of the Budget (Circular A-21 issued for Government-wide application). These cost principles provide for fair and equitable costing under the particular circumstances prevailing at educational institutions. This includes a logical division of direct and indirect costs flowing from the fund accounting systems employed by educational institutions. "In regard to the various questions asked by your committee with respect to the imposition of a 15-percent indirect cost limitation, if such a limitation were imposed on the funds used to pay for DOD research performed by educational institutions, the institutions might be said to have three alternatives: (1) Absorb the additional costs, (2) make radical changes in the logical costing pattern (division between direct and indirect costs) in order to get the maximum amount of costs classified as "direct" so they can be reimbursed and increase the base to which the 15-percent rate would apply, or (3) drastically curtail the research activities vital to the defense of the Nation. Actually, in our opinion, the institutions would be forced to curtail DOD research activities because they simply could not afford to absorb the additional indirect costs or install the cost-accounting procedures necessary to change the logical costing pattern. "In view of the importance of university research to DOD research and development programs as outlined above, curtailment of the university research activity for DOD such as a flat rate would impose, would constitute a serious impediment to the research and development programs vital to the Nation's defense and security. "It is advantageous to the military not to erode the strength of our educational institutions in their role of developing our national scientific resources. The ability of most educational institutions to share in the support of these increased activities in research is limited since this expansion has grown to the point where only a portion of its cost can be borne adequately by the funds obtained from traditional sources. "To the extent that the indirect costs in this expanded research program are not reimbursed by the Government, the additional burden thrown on educational institutions would require them to "(1) Use unrestricted funds from other sources for this scientific research, thus diverting funds from other activities to science; or "(2) Restrict the volume of research in science to the level at which they can carry the portion of costs imposed on them. "If institutions were required to absorb the nonreimbursed indirect costs of military research, they probably would find it necessary to draw upon other unrestricted funds available to them. Obviously, moneys from "restricted" endowments and gifts may not be used for this purpose. Since student fees do not ordinarily meet the costs of instruction, the burden, therefore, must fall on those funds normally used to maintain an institutionwide balance in instruction and research; namely, current income from "unrestricted" gifts and endowments. Any significant drain on this important source of support represents a serious threat to the institution's financial and functional integrity. The difficulty in securing gifts and endowments as sources of income, during the past 15 years, when coupled with the effects of inflation has only served to aggravate the problem. "The problem of absorbing the indirect costs of research in public institutions is somewhat different but no less pressing. State legislators and citizens expect that State funds will be used first and foremost for student instruction although direct State contributions for research in such fields as agriculture have been substantial and widely approved. While State appropriations may be used to meet some of the nonreimbursed costs of federally supported research, there are real limits on the extent to which this diversion may be permitted by those responsible for the provision of these funds. "With respect to the question, 'Why should the Department of Defense exceed the payments made by the Department of Health, Education, and Welfare in this field?' the 15-percent limitation attached to public health grants caused one university to make a contribution during 1 year of approximately $244,000 in order to make up the difference between overhead costs experience and the amount permitted under grant funds. The enlargement of the foregoing policy to include a similar limitation on Department of Defense work at this university as well as others would seriously hamper if not halt much research work vital to the national defense effort. Considerations such as these support the President's request that the limitation be removed from the HEW appropriation. "To further indicate the effect a 15-percent limitation would have on current Department of Defense research, the following examples are listed to show existing overhead rates stated as a percentage of direct salaries and wages and scope of programs at a few of the many universities engaged in Department of Defense research and development. 87846 0-62- 4 "From the above table of examples it is obvious that many very critical areas of research would be seriously jeopardized if an arbitrary reduction in overhead rates to 15 percent were to be effected. The action would involve a Department of Defense university research program of approximately $350 million." Mr. LAIRD. Your statement is the same kind of statement the people in HEW give us, you know. We have had every university president in the country in here practically in the last few weeks. The point, though, you have some contracts which do not have this range between 8 and 45 percent. You have some contracts paying 130 percent. Dr. BROWN. Those, I think, would have to be looked at to see whether there were not special circumstances. I think in the case of the Defense Department, the overhead rate will depend on how many other contracts they have not done this way. Mr. LAIRD. You have some grants. The highest one I was able to find was 113-percent overhead. Dr. BROWN. Let me say, Mr. Laird, that looks high to me, too. That sounds more like the Defense contractor Mr. MAHON. Do some good research work on this and give us the facts. This is a significant matter. Dr. BROWN. Yes, sir. Mr. TEAGUE. That is all I have, Mr. Chairman. The CHAIRMAN. Any questions? Mr. VAN PELT. No questions. The CHAIRMAN. Mr. Karth? Mr. KARTH. Mr. Chairman, what seems to have prompted this sudden interest of the Appropriations Committee in this limitation? Have abuses been uncovered? If so, are the claims of abuses valid? Would you care to give us your appreciation on why this sudden limitation? Dr. CLARK. Mr. Karth, we are not aware of any abuses that have been uncovered. This is a point that was of interest to me when I was reviewing the Mr. KARTH. So to your knowledge there have been none? Mr. KARTH. I wonder if the gentlemen with you there would address themselves to the question. Mr. EINHORN. We have, of course, seen the newspaper stories and read some of the House committee reports with respect to the difficulties that NIH had, but that is all we have done on that. Dr. Clark was addressing himself to what we know about NASA. We have not seen abuses here. Mr. KARTH. Are you aware of any abuses in any other agencies, or, at least, alleged abuses, and if so, what are they? Mr. EINHORN. The only abuses that I have seen alleged are those which relate to this commercial firm which received a grant from NIH. I think it was from NIH. Somewhere in HEW. The CHAIRMAN. You only know that from newspaper reports? Mr. EINHORN. From published material. Not from my own personal knowledge. Mr. KARTH. But that was subject to the 15-percent limitation; was it not? Mr. EINHORN. Yes; it was. Mr. KARTH. You don't know of any alleged abuses outside of the jurisdiction of HEW where the 15-percent limitation did not apply, do you? Mr. EINHORN. The National Science Foundation had a 20-percent limitation, which used to be 15 percent. I don't know of any abuses there, if that is your question. Mr. KARTH. In the determination of costs, as set out in Circular A-21, aren't the guidelines sufficiently rigid, or stringent, to prevent abuses? Mr. EINHORN. The guidelines are good for the determination of costs. Mr. KARTH. This whole question involves the determination of costs, does it not? Mr. EINHORN. Yes, sir. As I understand it, the limitation was not designed to I know very little about the basis for the 20 percent rather than some other percent-as I understand it that limitation was not designed to do anything but limit the amount of costs that would be paid to a university. In other words, it would be an encouragement, I suppose, of cost sharing. Mr. KARTH. Do you know? Dr. CLARK. No; I don't. Mr. EINHORN. I don't know anything more than that. I did not think the 20 percent was directed toward abuses. Mr. KARTH. That is all. The CHAIRMAN. Mr. Mosher? Mr. CASEY. In your grants, what is the highest percentage of indirect cost, approximately? Dr. CLARK. Dr. Smull. Dr. SMULL. I do not have, specifically, that figure. These tend to vary. I think there have been overhead determinations based on A-21 which will run between 60 and 70 percent. Mr. CASEY. Some have run Dr. SMULL. Of salaries. This is of salaries, this is percentage of salaries only. Mr. CASEY. Salaries only? Dr. SMULL. Yes. Mr. CASEY. How about the total cost? That would bring it down? Dr. SMULL. Yes. Mr. CASEY. The percentage down? Dr. SMULL. Yes, sir, bring it down appreciably, depending on the nature of the investigation. If it is an experimental investigation, the percentage of total would be quite a bit less. Mr. CASEY. This limitation that they put on in HEW, has that been on everything, that is to say, has it been applied to total cost of the whole program? Dr. SMULL. I am not familiar with specific details, but this has been the limitation. The limitation has been on direct cost, as I understand, total direct cost. Mr. CASEY. So they would not single out salaries and separate that, apply the 20-percent limitation and then disregard the rest of the project? Dr. SMULL. No, sir. Mr. CASEY. When they talk about a limitation they are talking about the overall cost, then, is that correct? Dr. SMULL. That is our understanding; yes. Mr. CASEY. Based on the overall cost, what is the highest that you recollect, generally? I know you can't be specific without having records. But approximately what is the highest percentage of overall cost that NASA has borne? Dr. SMULL. I would say this probably would run 30 to 40 percent on a purely theoretical investigation Mr. CASEY. Type of project? Dr. SMULL. Type of project. Mr. CASEY. That determination would make it vary as to what the percentage of cost would be attributable to the particular project, would it not? Dr. SMULL. Yes. If you are trying to compare costs as determined by A-21 on the basis of which of the overhead costs are determined |