I work as a federal contractor. It's very true (epistemic status: my managers and project leads tell me as much and I act accordingly, I don't deal with it directly nor understand the bureaucratic larger picture). You will not get funding from Department X again if you ask for more money on a project than you wind up spending. Now, is that the sin of overquoting, or the virtue of overdelivering? For some reason, every agency treats it as the former, and I haven't the foggiest idea why. My coworkers acknowledge how stupid and perverse of an incentive it is, yet treat it like a fundamental force of nature.

Most solutions to this problem are essentially what the OP recognized as nakedly illegal---that is, exaggerating productive hours---but most contractors are savvy enough to do it in less auditable and more positively regarded ways, such as stretching out timelines (four 20-hour work weeks raise fewer flags than one 80-hour week), adding more chefs than the kitchen calls for, or funding unnecessary little side projects. Straight-up tampering with timecards is an impatient and dangerous way of achieving (IMO) the same wasteful evil as happens everywhere else in the public and private sector.

The Dutch University of Delft systematically 'maximized' grants and shuffled the money between projects, according to investigative journalists of the NRC[1].

1 https://www.nrc.nl/nieuws/2024/02/15/het-subsidiepotje-moet-...

I work with people who are well smart enough to know that.

It’s also still a reasonable question to ask “well, last year we budgeted $15M and you got acceptable results while spending only $14M; perhaps you only need $14M/yr…” And despite its reasonableness, many people would prefer to oversee a $15M/yr budget.