Restore Government R&D to its Historical High
For eighty years, research and scientific advancement funded by the U.S. government has been a critical source of America’s global leadership in technology and innovation. Federal R&D investment has supported large-scale national achievements like winning World War II, splitting the atom, and landing men on the moon, and fueled the development of new technologies that spawned new industries like wireless telecommunications, computers, digital information, and genome-based pharmaceuticals.
In recent decades, however, the federal government’s commitment to research and development has waned dramatically. After peaking in 1964, federal R&D investment as a percent of GDP and total federal outlays has plunged to the lowest levels in 60 years, undermining America’s technological edge and raising alarming strategic challenges, particularly from China. In addition to enhancing the tax treatment of commercial R&D (see below), CAE urges policymakers to restore U.S. government funding of R&D to the historical high of 2 percent of GDP. To do so, funding would need to increase from the current $145 billion annually to about $450 billion.
Under the leadership of Vannevar Bush, Dean of MIT’s Department of Engineering and, most notably, science advisor to President Franklin D. Roosevelt and the first Director of the Office of Scientific Research and Development established in 1941 (later replaced the National Science Foundation), the U.S. government carried out wartime research and development that led to breakthroughs that helped win the war, including advances in radar technology, computers, cryptography, and the Manhattan Project to build the atomic bomb. Following the successful launch of the “sputnik” satellite by the Soviet Union in 1957, federal R&D spending increased quickly, peaking at 2 percent of GDP and 10 percent of total federal outlays in 1964, after President John F. Kennedy set America’s sights on the moon. At that time, the federal government funded two-thirds of all R&D conducted in the United States – an amount greater than the R&D spending by the rest of the world’s governments and businesses, combined.
Over subsequent decades, however, growth in federal R&D spending slowed. R&D outlays grew at an average annual rate of 5.6 percent between 1953 and 1985, then fell to an average annual rate of just 0.4 percent between 1990 and 2016. By the mid-1990s, federal R&D investment had fallen below 1 percent of GDP, where it has remained ever since. As Goldman Sachs pointed out in a May 2020 report, “In FY 2019, federal R&D spending equaled 0.6 percent of U.S. GDP and 2.8 percent of total federal outlays, the lowest in over 60 years.” U.S. R&D investment as a percent of GDP now ranks 10th in the world, behind major economic competitors such as Japan, South Korea, Taiwan, and Germany.
Particularly alarming is the decline in federal funding of basic research. Basic or pure research is conducted to gather general information and to expand existing knowledge and understanding, whereas applied research is conducted for more targeted purposes – to resolve a particular question or to achieve a specific commercial objective. In this sense, basic research is the foundation for applied research, establishing the context of knowledge and understanding within which additional progress can be made regarding specific inquiries. While businesses conduct some basic research, they are not well suited for such projects, given the scale and risk that basic research entails together with the unknown practical outcome of such inquiry.
Government funding of basic research has played a critical role in driving many technological breakthroughs that have helped U.S. industry become a global technology leader, and in the creation of iconic America companies – including Sun Microsystems, Pfizer, Genentech, Cisco, and Google – which trace their origin back to federally funded basic research. In fiscal year 2017, the federal government funded $40.2 billion in basic research, down 13 percent from 2005 in inflation-adjusted terms. This decline followed more than 50 years of steady increases.
As the United States has reduced its commitment to R&D, other nations have dramatically expanded theirs. Over the period 2000 to 2017, India increased domestic R&D spending at an average annual rate of 8 percent, South Korea by 10 percent, and China by nearly 20 percent.
The competitive threat from China is of particular concern. In recent years, China has targeted critical industries like petrochemicals, electronics, metals and materials, machinery and equipment, pharmaceuticals and biotechnology, information technology, and artificial intelligence. China’s Belt and Road infrastructure initiative, the Made in China 2025 plan to dominate global manufacturing, and the China Standards 2035 blueprint are critical aspects of China’s ambition to be the 21st century’s unrivaled economic super-power – all supported by robust research and development. According to the National Science Board, China likely surpassed the United States in R&D funding for the first time in 2019.
If America is to retain its status as the world’s innovation leader, the multi-decade decline in federal government’s commitment to scientific research must be reversed. Tripling federal R&D funding is a major challenge given current fiscal circumstances, but there is little doubt that America’s economic future depends on such a commitment. To argue that we can’t afford to meet the competition is to argue that we can’t afford to own the future.
Restore the Research and Development (R&D) Tax Credit to the Most Favorable in the World
The Research and Experimentation Tax Credit – commonly known as the research and development (R&D) tax credit – was created as part of the Economic Recovery and Tax Act of 1981 to incentivize technological progress and innovation by allowing businesses to deduct a portion of the cost of research and product development from their taxable earnings. The United States was one of the first countries to incentivize R&D by way of the tax code and claimed the world’s most generous tax treatment of R&D into the early 1990s.
Since its introduction, the R&D tax credit has been shown to be a powerful driver of innovation and economic growth. A large and growing body of research indicates that R&D investment is associated with future gains in profitability and market value at the firm level, and with increased productivity at the firm, industry, and broader economy levels. R&D also has significant “spill-over” benefits, as research conducted by one firm can lead to progress that increases the productivity, profitability, and market value of other firms in related fields. A 2015 analysis of the R&D expenditures of 15 OECD countries over the period 1990 to 2013 concluded that a 1 percent increase in R&D spending accelerates economic growth by 0.61 percent. Research also shows that R&D investment has become increasingly mobile, with businesses and corporations locating more of their investment outside their home countries. Investment location decisions are determined by many factors, including the growth of foreign markets, production costs, talent and skills availability – and tax and other incentives offered by governments.
The United States no longer claims the most favorable tax treatment of corporate R&D. A recent analysis by the Information Technology and Innovation Foundation has shown that the United States now ranks 24th out of 34 nations studied in terms of R&D tax treatment. More favorable tax treatment of R&D means that foreign companies are able to invest more heavily in relative terms, with potentially profound implications for innovative advantage over the longer term. Moreover, as global companies – including American companies – look for places to invest in R&D, many other countries are now substantially more attractive than the United States.
Restoring America’s preeminence in incentivizing R&D will not be cheap. But losing the innovation advantage our nation has enjoyed for 80 years would be much more costly. Moreover, academic research regarding the stimulative effect of R&D investment on the rate of economic growth and job creation, as well as the significant “spillover” impact of such investment, strongly suggests that any short-term loss in tax revenue will be substantially or even entirely recovered through faster economic growth and job creation over the longer run.
Enhance the Tax Provisions of the PATH Act
The R&D tax credit would be particularly relevant for startups, which often incur substantial losses in their early years due to development of new products, services, methodologies, and techniques – and for whom preservation of cash flow and operating capital is crucial to survival. And yet, until recently, startups were largely shut out of any benefit associated with the credit because it can only be applied against taxable earnings, which many startups don’t have for years, and sometimes many years.
The Protecting Americans from Tax Hikes (“PATH”) Act of 2015 made a number of improvements to the application of the R&D tax credit, perhaps most notably finally making the credit permanent after numerous extensions and expirations since its creation in 1981. Now certain of the credit’s availability, businesses can make investment decisions more effectively and efficiently. In addition, the PATH Act addressed the disconnect between the policy intention of the R&D credit and startups by allowing new businesses to apply the credit against payroll taxes, rather than income taxes, up to $250,000 annually. To qualify, companies must have had gross receipts for five years or less and gross receipts of less than $5 million for the tax year the credit is applied.
CAE recommends enhancing the PATH Act’s tax provisions for startups by: 1) aligning the criterion for eligibility with that of Section 1202 of the tax code; 2) raising the eligibility threshold; and, 3) increasing the deduction limit.
First, CAE recommends that the eligibility criterion be changed from gross receipts to gross assets. This change would make the PATH Act provisions consistent with the tax code’s definition of “Qualified Small Business,” (QSBs) which are currently defined as businesses with “less than $50 million in gross assets.” This consistency would simplify and harmonize related provisions of the tax code, facilitating compliance and reporting by investors and, thereby, promoting capital formation.
Second, CAE recommends that the eligibility threshold for the PATH Act’s payroll tax provisions be raised from the current definition of QSBs of “less than $50 million in gross assets” to “less than $100 million in gross assets.” The current gross asset limit is too restrictive, as the high costs of innovative research, coupled with valuable intellectual property and successive rounds of financing, often push new innovative companies over the $50 million limit (see recommendation regarding Section 1202 on page 31 below).
Finally, CAE recommends that the payroll tax credit deduction limit be raised from the current $250,000 to $1 million. Doing so would align U.S. policy with similar policy in Canada, a major innovation competitor to the United States.
Streamline Technology Transfer and Commercialization of Government-Funded Innovation
The principal way new innovations and technologies are transmitted into the economy for the benefit of broader society is through commercialization, either by way of licensing to existing businesses or through startups. But too often, promising innovations stemming from federally-funded research face a slow, cumbersome, and uncertain path to commercial viability. Discoveries with significant social and economic benefit often take years to reach the commercial marketplace, while other innovations never leave the research lab. More streamlined and efficient commercialization of federally-funded innovation would dramatically enhance the competitiveness and growth capacity of the U.S. economy.
On May 1, 2018, the National Institute of Standards and Technology (NIST) issued a Request for Information (RFI), published in the Federal Register, pursuant to its Return on Investment (ROI) Initiative for Unleashing American Innovation, the purpose of which is to dramatically increase returns on federal investment in research and development through reform of tech transfer and commercialization procedures. In response, CAE submitted a comment letter on July 30, 2018.
In April of 2019, NIST released its final Green Paper summarizing stakeholder input received from hundreds of experts and organizations representing thousands of companies, universities, federal laboratories, and other institutions. The paper focused on 15 major findings by NIST to help inform decision-making and implement reform actions by the relevant departments and agencies – eight of which would require revisions to the Stevenson-Wydler Technology Innovation Act of 1980.
On December 10, 2020, NIST announced that it had transmitted an ROI legislative package for modernizing the Stevenson-Wydler Act to the Senate Committee on Commerce, Science, and Transportation and its Subcommittee on Science, Oceans, Fisheries and Weather, as well as the House Committee on Science, Space, and Technology and its Subcommittee on Research and Technology for consideration. The ROI legislative proposal responds directly to the findings summarized in the NIST Green Paper. CAE strongly supports the enactment of the NIST-suggested reforms.
The National Science Foundation’s (NSF) Innovation Corps (“I-Corps”) program was created in 2011 to accelerate the translation of scientific and engineering discoveries into technologies, products, processes, and services that enhance the nation’s competitiveness, benefit society, and promote economic growth. Developed by famed Silicon Valley entrepreneur Steve Blank and based on his “Lean Startup” model, I-Corps provides training and mentoring to university-based researchers and faculty to explore the commercial potential of NSF-funded research. The goals of the I-Corps program are to: 1) spur translation of fundamental research to the marketplace;
2) encourage collaboration between academia and industry; 3) train NSF-funded faculty, students, and other researchers in innovation and entrepreneurship; and, 4) maximize the potential of NSF’s investments in basic research through creation of a National Innovation Network (NIN) comprising I-Corps “Nodes” (central training sites) and sites (universities) that work cooperatively to build, utilize, and sustain the national innovation ecosystem.
Since its launch in 2011, the I-Corps program has been adopted by several other federal research agencies including the National Institutes of Health, the Department of Energy, the Department of Health and Human Services, and the National Security Agency, and has delivered remarkable results – to date, the program has trained over 1,200 teams of scientists and engineers, resulting in 583 startups and $300 million in follow-on funding. The FY 2019 funding request for I-Corps was just $30 million. CAE recommends that I-Corps’ resources be significantly increased and that the program be expanded to include all research agencies, including through widespread integration into other relevant R&D programs such as the Small Business Innovation Research (SBIR) program.