This research studies the relationship between state government budgetary policy and research universities' incentives. In particular, this paper examines the effects of state government decisions that effectively tax universities by controlling universities? receipts of indirect cost recoveries earned on federally sponsored research. The effects of this policy decision on universities are examined at both a macro level (the overall rate of indirect cost recoveries) and at a micro level (the types of management accounting systems employed to support rate negotiations). Employing both archival and survey data, the results of this research demonstrate that universities subject to state taxation of indirect cost recoveries tend to have lower indirect cost rates and use less elaborate management accounting systems to support rate negotiation efforts.