If we had a set of standards for the indirect cost rates for various types of charitable organizations along the lines suggested in the “Pay-What-It-Takes Philanthropy” article, foundations would have two clear options. Either pay total costs, or acknowledge that they are only willing to pay a lesser percentage and demand that the organizations compromise their missions or raise matching funds to cover the shortfall.
Let’s assume that a foundation knows a grantee’s actual indirect cost rate and acknowledges its reasonableness. Under these circumstances, what justifications might the foundation have for paying less than full indirect costs under a project grant? (The issue of indirect costs arises only when a foundation makes project grants, as distinguished from unrestricted, general operating support grants. But project grants are perfectly appropriate when a grantee’s activities are not well aligned with a foundation’s mission.)
Let’s consider a foundation that makes a project grant to a small research organization to assess the potential for an asthma-prevention program, and subsequently makes a project grant to a youth-serving organization to implement the program. Let’s assume that the foundation is impact-oriented and also feels constrained by principles of fairness. How should it decide whether to pay the grantees’ indirect costs?
If impact were the foundation’s sole consideration, its decision about indirect costs would turn on whether it is making a one-time grant of relatively short duration or needs the organization around for the long haul.
If it is a one-shot deal, as the research grant might be, the foundation could take advantage of whatever slack the organization has—and virtually every organization has some. It could underpay—that is, pay only direct costs—and let the organization make up the difference if and how it can. Presumably, if the organization cannot maintain itself and goes out of business, that is a matter of indifference to this impact-only foundation, which believes that it will not need the organization in the future. It’s worth noting, however, that the organization which, for this foundation, is a one-off grantee, may be a core grantee for another foundation, and vice-versa. So even in this case, the foundation should consider its decision in the context of the entire ecosystem.
If the foundation knows a grantee’s actual indirect cost rate and acknowledges its reasonableness, then a decision to underpay is arbitrary: The foundation might just as rationally say that it will only pay 75 percent of total costs, or any percentage it chooses. In effect, it is demanding that the organization match some proportion of the grant from existing resources or new gifts from others.
It the foundation decides to make a grant to implement the program, it will want the implementing organization to endure at least long enough to carry out the program—probably a period of several years—and, after that, for an indeterminate time to continue the program if it is successful. In this case, underpaying indirect costs will exacerbate what the authors and others have aptly described as the “nonprofit starvation cycle.” Deprived of full payment, the organization may, for example, put off upgrading the computer system to keep track of its disadvantaged clients or forgo sending staff to a training program to improve their work. It’s not just the organization that suffers, of course, but the very beneficiaries that the foundation seeks to serve. So the foundation may decide that it must pay full costs to assure the organization’s vitality as long as the foundation cares about these clients.
Turning to the matter of fairness, does a foundation treat the grantee unfairly when it makes a grant without paying its full costs? To be sure, the organization does not need to accept the grant. In reality, however, many organizations, feeling unable to reject the funds, accept the grant and scramble to fill the gap by forgoing strategic investments in infrastructure or training—again, at the expense of their beneficiaries—or through “creative” accounting or from other sources—for example, small individual contributors or foundations that provide general operating support.
Is it fair to ask other donors to pay the indirect costs that the foundation won’t? Perhaps they would recognize that this is essentially a demand for matching funds and be grateful that the foundation is paying most of the costs for a new program. But for better or worse, many donors are averse to paying indirect costs, strongly preferring that their funds go directly to programs that provide services to the beneficiaries—the same sort of myopia that motivates our foundation to pay less than full fare.
So the burden of justification falls on foundations. They should be asked to justify their refusal to pay the actual costs of the activities they want grantees to perform, and I haven’t seen many foundations try to do that.