PREVIOUS ADVICE 
A couple of years ago I accepted a job at a top-quality, small, predominantly undergraduate college. I love teaching, but I also love research, and on hiring me the college said that's just what they were looking for. I was conscious of (some of) the challenges I was likely to face--the teaching load, doing research with undergraduates, and all that. But, to quote Jodie Foster in the movie "Contact", "I had no idea!"
As the end of my second full year approaches, I'm worried that I made a mistake. Don't get me wrong; I'm doing okay. My teaching reviews are pretty good, my research program is up and running (well, toddling along, at any rate), and I have reasonably good relationships with many of my colleagues, and most of them seem to have a high opinion of me.
So why am I writing? I guess I'm feeling sorry for myself. While my senior colleagues may consider research valuable, only about a third of them do any real research, and, more worryingly, many of the most senior non-research-active faculty members serve on key research-related committees, which are making really stupid decisions, in my opinion.
I could tell lots of stories--none of them truly horrifying--but I'll leave you with just one, the most recent. The institution is taking a chunk of my grant money--technically a part of the "Indirect Costs"--and instead of using it to heat and light the lab, they?re giving it back to me. So far, so good. But they're taking another chunk and giving it to other faculty members, including some in--gasp!--the humanities, and others who haven't done research since the Nixon administration, whenever that was. Is this even legal?
Overwhelmed by Mediocrity
When I first read your message, I was as exasperated as you seem to be, positively bouncing off my seat with indignation. Then I calmed down, did some thinking (always a good idea), made some phone calls, and completely changed my mind. Not only is what your institution doing legal; it's a good idea. Still, I don't intend to miss out on this opportunity to rant about the lack of support for research at some institutions, not all of them small.
In one chemistry building I heard about, they removed the freight elevator and replaced it with a passenger elevator, so that when the new NMR arrived they had to haul it up the stairs.
And then there's the college where they blocked off a road and made it pedestrian only, so that delivery trucks couldn't get close to the building.
And the electricians--let's not forget the electricians--who do work in the building or elsewhere on the campus but don't bother to warn you that there will be short-term fluctuations and power outages. It's not really their fault--the administration should make sure this doesn't happen--but there's nothing like a power outage, and the subsequent surge, to (shall we say) "modify" sensitive equipment in, shall we say, an uncontrolled manner.
Health and safety? Don't get me started. Three words: broken fume hoods. Two more words: hazardous waste. One institution I came across asked a research-active faculty member to take on the job of solving the department's health and safety problems. The budget: $3,000. Heck, the EPA fines alone are likely to be twenty times that much.
As I've written before, every year several outstanding young scientists choose to work at small colleges, perhaps because they love teaching, or maybe it's because it's their only offer, or it's close to family and friends. Small-college scientists are a great, partly untapped, scientific resource. Unfortunately, in addition to the challenges of doing research with undergraduates while teaching four or more courses per year, they find themselves faced with obstacles strewn in their paths by oblivious administrators.
So, when I fail to share your outrage about your institution's grant-redistribution policies, it's for cause, and not for a lack of general sympathy with your point of view. Is what your college is doing legal? Absolutely. "What happens with those costs is up to the institution," an NIH official told me in a telephone interview. "It's not something that we control or monitor." NSF takes a similar attitude.
The key to understanding "overhead" expenses (also known as "indirect costs," or, at NIH, "facilities and administration,") is the negotiation of the overhead rate. Every institution must negotiate a rate with the various funding bodies. For NIH grants, the negotiation is carried out by the Division of Cost Accounting of the Department of Health and Human Services. I'm not sure who does the work for NSF grants. But whatever agency funds your work, rest assured that it's a rigorous process, based on sound accounting principles. Your institution must document, to the agency's satisfaction, additional expenses it incurs that cannot easily be assigned to a particular account, things like heat, electric bills, personnel-department time, and other legitimate administrative and facilities-related costs. Once these are all documented, an overhead rate is agreed on.
When your institution decided to "give back" some of that money--indirect costs--to you and to your colleagues, it's not because they aren't incurring those indirect expenses. They are. It's an illusion of accounting. For all its likely faults, your institution has decided to subsidize research, yours and your poet colleague's, by an amount equal to some fraction of their legitimate overhead expenses. It's a research subsidy, direct from the institution. "That shows a strong commitment to research," says my NIH source. As it's coming directly from the institution and not really from your research grant--or even from the funding agency--you should thank them.
I'm in my second year as a faculty member, and I'm still seeking research funding. NSF grants last for only 3 years, but I'm afraid my project will take longer than that. Furthermore, I'd hate to lose my funding just before I come up for tenure. For both reasons, a longer grant makes sense for me.
What should I do?
That's easy: ask NSF for a longer-term grant. Though the typical grant term is 3 years, NSF is more flexible about that than most people realize, at least for their standard research grants (specific programs may have stricter time limits). If you can make a strong argument for longer-term funding--and it sounds like you can--put it your grant proposal. If your project is certain to take more than 3 years, tell them why. If your renewal is likely to interfere with your tenure process, tell them that as well. The reviewers and panelists are likely to be impressed that you've thought things through so well. Furthermore, your own career development--including tenure--is a legitimate "broader impact," which NSF is charged with considering, alongside intellectual merit, as they evaluate your proposal. Especially if you can keep the budget lean--ask for everything you need, but no more--I think you can make a very strong case for longer-term funding.
Best of Luck,