Libertarian State Leadership Alliance

Letters on Libertarian Strategy


Direct and Indirect Costs

This is the first of several letters discussing how the LNC should spend its money. In this letter, I discuss sources of income and the concepts of direct and indirect costs. Direct and indirect costs are fundamental for understanding what you are doing when you spend money. If you already know about indirect costs, you may find this leTOPICtter to be a bit familiar, but it is very important for understanding what we should do to spend out money.

One of the most fundamental activities of the Libertarian National Committee is raising and spending money.

Where do we get money?

1) Above all, we are a membership organization, taking dues from members.

2) We receive restricted and unrestricted donations.

3) We may have other activities, some of which generate income.

4) We could make arrangements that would yield permanent, stable income.

For each source of income, there are base expenses:

1) Corresponding to membership dues, we have membership costs. We maintain membership records, remind people to renew, provide issues of the newsletter, (for members from UMP states) supply state organizations with their fraction of the dues, etc.

2) We receive donations because we do fundraising, including membership recruitment efforts that also ask for donations. Corresponding to the fundraising costs are fundraising expenses. There are telephone calls, letters, donation reminders, etc.

3) Other activities also have costs. For example, the Defend Your Privacy website and other websites of the same style cost money or donations in kind of programmer time to deploy. Donated programmer time is a specialist activity, in the sense of "Stand Up for Liberty!". The effort that went, e.g., into Eric Garris's excellent site would not necessarily have been available for other causes.

What sort of costs are there?

Costs are of two sorts. Direct costs are expenses that are obviously directly linked to the activity that the support. For example, when we recruit a member from a UMP state, the money that we send off to that state under the UMP plan is a direct cost. Note that we might have projects that have direct costs but produce no income. I listed above projects that do produce income, but all projects will not produce income.

In addition to direct costs, we also have indirect costs.

What are indirect costs? We have office space, employees and their salary and fringe benefits, administrative staff, etc. These are all real expenses -- money out the door. Look at all of the money that we spend. Some spending is readily assigned to a particular project. Spending that you assign to a specific project is a direct expense. Other spending is difficult to allocate to a particular project. Spending that is not readily assigned to a specific project is readily described as an indirect expense.

Indirect spending is just as legitimate as direct spending. We draw the distinction between direct and indirect spending because it is too expensive or complicated or timeconsuming to allocate some expenses to specific projects. The decision as to whether particular costs are treated as direct costs directly assigned to a particular project, or whether those expenses are counted as indirect costs, is largely arbitrary. One can rationally discuss whether a particular expense should be assigned to a specific project or counted as an indirect expense. By changing how you allocate spending between projects, you can change whether you see a project as being effective or ineffective relative to its costs.

There is one totally ironclad rule in financial analysis. Every cost must be identified either as a direct cost or as an indirect cost. There are no costs that are neither direct nor indirect. Once all costs are identified as being direct or indirect, all indirect costs are assigned to projects in a uniform way. For example, one could divide the indirect costs over the direct costs in a proportionate way by means of an "overhead rate". An "overhead rate" looks like a tax. You say "we have $50,000 in direct expenses for this project, the overhead rate is 50%, and therefore this project is assigned $25,000 in overhead charges."

I should emphasize that the overhead rate is a calculated quantity. The process for calculating the overhead rate is to say "We have a total of $2,000,000 in direct costs, and $1,000,000 in indirect costs; the overhead rate is the ratio of those two numbers, or 50%". The overhead rate is not a number that you set in advance; it is strictly a number that comes out of the process that automatically assigns every dollar of indirect costs to *some* project. However, one can make some estimates as to what overhead rates are. Typical university overhead rates calculated as noted above are in the range 40-70%. Typical overhead rates for a civil engineering contract or industrial firm are around 150%. You choose your management model, universities being typically much lighter in terms of administrative staff and salaries at the upper end, and you can then ask if your numbers look reasonable or not.

There are other ways of dividing indirect costs over projects. Some of them are much less intuitive than the process described above. However, no matter which method you use, an honest budget description identifies every expense as a direct or indirect cost and distributes the indirect costs over the projects and their direct costs.

Please propagate this letter to other appropriate Libertarian lists, such as state lists.

ASIDE: I noted above a fourth process for raising money. Let's consider that briefly. How else could the Libertarian Party have identifiable financial support? One alternative is to take money and invest it as an endowment, noting that the success of our economic system will eventually return a sound investment many-fold.

In my opinion, based on the practical realities of human nature, endowment funds should be separately held and invested by a Libertarian Party Endowment Trust. The Trust would have a set of Trustees appointed with long overlapping terms. The Endowment Trust would be responsible for spreading its money between income-producing securities and properties (mostly bonds), and equity investments (mostly stocks) in an orthodox manner. Under modern conditions it is generally recognized that the soundest distribution of investments for a permanent organization divides between bonds and stocks in a ratio around 30:70 or 25:75, with a 5 or 10 percentage point bracket in this ratio. The endowment trust would also be responsible for setting a return rule. A return rule sets a period over which the value of the trust is averaged, and the percent of the averaged value of the trust that is returned to the primary organization. A typical averaging period is in the range 1-3 years. Typical return percentages are in the range 4-6%, the return percentage being set so that in the long term the real value of the return is conserved or increases. To protect against several obvious abuses, one needs a rule limiting the frequency with which the return rule may be changed, and the allowed size of each change.

There are substantial election law issues relating to activities that a Libertarian Party Endowment Trust might fund. Under some conditions, it might become relevant to maintain two trusts, one based on hard-money contributions (which may legally be invested between elections) and a separate trust based on soft-money contributions. The exact targets on which the return funds may be spent will be determined by election laws. Under some future conditions, it may be the case that the returned funds could no longer be controlled directly by the party, but would have to be entirely under the control of a set of endowment trustees.

George Phillies

The Clean Slate Action Program Committee
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