February 27, 1992
"Research Recession - Development Limps Along"
San Jose Mercury News
By Timothy Taylor
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ALTHOUGH the event didn't attract much attention, the growth of U.S. research and development spending slowed down sharply about five years ago. Now the slowdown has turned into an R&D recession.

The National Science Foundation has announced that overall levels of both government and private R&D spending actually declined in 1990, and hints that 1991 won't look much better. The Industrial Research Institute forecasts that industrial R&D spending won't grow in 1992, either.

With the clarity of hindsight, the present stagnation of U.S. R&D spending can be traced back to the early 1980s. On the surface, the R&D effort appeared to be going swimmingly. Total R&D spending increased 7 percent per year faster than the rate of inflation between 1981 and 1985.

Since technological progress is widely recognized as the single most important component of economic growth, and research and development is a key contributor to technological progress, these figures were widely taken to be a promising sign of long-term economic health.

But just beneath the surface, the picture was murkier. Although government support for research and development was growing nearly 5 percent faster than inflation from 1981 to 1986, defense-related R&D was growing 11 percent per year faster, while civilian-related R&D (adjusted for inflation) was actually shrinking by 4 percent per year.

In the private sector, the commitment of R&D money rose 8 percent per year from 1981 to 1985. But that seems due, at least in part, to a tax credit for research and development which was passed in 1981. When the tax credit expired in 1985, the growth rate for industrial R&D spending dipped to 1 percent per year.

During the last seven years, the R&D tax credit has been a prime illustration of government schizophrenia. After being allowed to die in 1985, it was renewed for 1986. Then it was renewed again for 1987 and 1988, but at a lower rate. Then it was renewed again in 1989, 1990, and 1991, and is now scheduled to expire in June.

If saboteurs had set out to make the R&D tax credit look unreliable, so that business wouldn't dare count on it, they couldn't have done much more than Congress has actually done.

In a study distributed a few weeks ago, economists Martin Neil Baily of the University of Maryland and Robert Lawrence of Harvard University pointed out that the four years when the credit was in full effect had the highest growth rate of industry-funded R&D of any four-year period since 1960. They wrote: "The pattern of R&D spending throughout the 1980s tracks rather closely the pattern of incentives in the credit."

The R&D tax credit does reduce corporate taxes by about $1 billion per year. However, Baily and Lawrence estimate conservatively that it increased R&D spending by $2-3 billion per year in the early 1980s.

But in addition to hobbling the R&D tax credit, the tax system imposed a whole new burden on R&D through a little-known regulation familiarly referred to as 861-8. This rule required companies with foreign sales to count some of their U.S.-based R&D as a cost of foreign production. As a result, they couldn't count the R&D as an expense on their U.S. tax bill.

James Hines of Harvard University recently compared the R&D spending of companies who were heavily affected by 861-8 with those less affected. He estimated that the 861-8 provisions collected $1.2 billion per year in extra tax revenue from 1987 to 1989, but reduced R&D spending by between $1.4 and $2.2 billion per year.

Raising the level of R&D spending will require contributions from both government and business. In fact, there's a natural division. Government should focus on basic, pre-competitive, "generic" technology where no individual firm may see a reasonable profit opportunity. Private companies should be focusing on getting new and improved products to market.

Federal support for civilian R&D has increased by about $4 billion since 1986 (adjusted for inflation), which means that it is now back to just about where it was in 1981, before it started declining. That's not adequate. Without spending any extra money at all, the government could immediately start shifting $10 billion to $15 billion from defense-related to civilian R&D.

Baily and Lawrence estimate that making the R&D tax credit permanent would increase private R&D spending by about $5 billion annually in the next few years. Resolving the 861-8 fiasco could increase R&D spending by another few billion dollars.

Steps like these may seem small-time; after all, they involve only a few billion dollars. But total U.S. spending on civilian R&D is only about $110 billion. From 1986 to 1990, civilian-oriented R&D (both government and private) increased by a total of only 6 percent, and any increases since then have been minimal.

A combination of shifting federal R&D money and an enlightened tax policy might increase civilian-oriented R&D spending by say, $17 billion to $22 billion, a rise of 15 to 20 percent. If U.S. citizens are to have top jobs in the high technology industries of the future, and enjoy using the magical products from those industries, they have a large stake in a resurgence in R&D spending.

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