It's the classic "overqualified for the job" idea. People with high intelligence tend to do poorly in jobs that don't use their intelligence and tax them with tedious tasks. I'd imagine being a "Statie" is mostly like all cop jobs -- filled with dull, repetitive paperwork and other routine tasks with no flexibility for intelligent and creative minds.
Their argument wasn't that he'd get fired, but mostly that he would surely quit because the job would drive him nuts and his intelligence would give him better opportunities elsewhere.
What's surprising is that he wasn't be lured in with a more lucrative Statie job/rank more suited to his intelligence after his undercover assignment. Surely Costigan isn't so much the genius that he was smarter than Martin Sheen's character or other senior investigators. It was like they expected him to go undercover, collect a big paycheck and then quit, when in fact he would probably be an amazing detective after this stint with all kinds of hard-to-get first hand knowledge of criminal enterprises and behavior.
The only thing that explains this forced retirement after undercover is either they fear for his life -- some kind of mob vendetta that taking down Costello wouldn't end, or they think for psychological reasons he would be a bad bet as a cop, vulnerable to engaging in criminal behavior (who best knows how to beat the system *and* be a criminal?) or just unstable.
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