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Figure 4-8

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Chapter 4: Research and Development: Funds and Technology Linkages

Federal R&D

• R&D by Federal Agency
• Federally Funded R&D by Performer
• Federal Research Funding by Field
• Federal R&D Budget by National Objective
• Federal R&E Tax Credit

In the president's 2006 budget submission, the federal government is slated to invest $132.3 billion in R&D, amounting to 13.6% of its discretionary budget (i.e., that part of the annual federal budget that the president proposes and Congress debates and sets). The current level of federal investment in R&D, both in absolute terms and as a share of the budget, is over an order of magnitude greater than what it was prior to World War II, when the government had no unified national agenda for supporting science. In its early days, the U.S. government fostered innovation primarily through intellectual property protection and relatively small investments in R&D, but World War II changed how the federal government viewed its role in the national R&D enterprise. During the war, penicillin, a new drug at the time, greatly reduced the number of deaths caused by infection among Allied forces. And advances in military research, such as radar, were critical contributors to the Allied victory. Recognizing these achievements, President Franklin D. Roosevelt wrote to Vannevar Bush, the wartime director of the Office of Scientific Research and Development, requesting recommendations for how science could be mobilized in times of peace as it was in times of war, specifically "for the improvement of the national health, the creation of new enterprises bringing new jobs, and the betterment of the national standard of living" (Roosevelt 1944). Vannevar Bush's response in 1945, a report entitled "Science—The Endless Frontier," provided a framework for a more active federal role in support of science. He argued that:

There are areas of science in which the public interest is acute but which are likely to be cultivated inadequately if left without more support than will come from private sources. These areas—such as research on military problems, agriculture, housing, public health, certain medical research, and research involving expensive capital facilities beyond the capacity of private institutions—should be advanced by active Government support…[W]e are entering a period when science needs and deserves increased support from public funds. (Bush 1945)

Bush's report was enormously influential, and many of its principles, including the importance of government support for R&D and of maintaining freedom of scientific inquiry, are evident in today's federal science policy and institutions.

Richard Nelson (1959) and Kenneth Arrow (1962) formalized the economic argument that the private sector generally invests less than the socially optimal amount in R&D. Briefly, the argument is that knowledge, the primary output of R&D, is nonrival and partially nonexcludable. That is, knowledge can be used by any number of actors at one time, and it is difficult or impossible to exclude others from using it. This being the case, firms will only invest in those R&D projects from which, through secrecy, patents, or some other means, they are able to recoup their investment plus an acceptable profit. The government endeavors to correct this market failure through a number of policy measures, the most direct of which is the funding and performance of R&D that would not, or could not, be financed or performed in the private sector. This section presents data on such R&D funding and performance as well as on the federal R&D tax credit, an indirect means of stimulating R&D in the private sector.

R&D by Federal Agency

Federal agencies are expected to obligate $106.5 billion for R&D support in FY 2005. Although more than 25 agencies report R&D obligations, the 5 largest R&D-funding agencies account for 94% of total federal R&D. These agencies vary considerably in terms of their R&D funding strategies, processes, and procedures, reflecting the unique mission, history, and culture of each.

Department of Defense

According to preliminary data, DOD will obligate $51.4 billion for R&D support in FY 2005. DOD funds more R&D than any other federal agency, representing 48% of all federal R&D obligations. More than 88% of these funds ($45.7 billion) will be spent on development, with $39.6 billion slated for major systems development (figure 4-8 ).[25] Industrial firms are expected to perform 70.4% of DOD-funded R&D in FY 2005. DOD accounts for more than 84% of all federal R&D obligations to industry in FY 2005. Federal intramural R&D and R&D performed by FFRDCs account for most of DOD's remaining R&D activity and represent 25.7% of its fiscal year total. According to the Office of Management and Budget (OMB), 72% of DOD's basic and applied research funding was allocated using competitive merit review processes with internal (program) evaluations in 2005.[26]

Department of Health and Human Services

HHS, the primary source of federal health-related R&D funding (largely through the National Institutes of Health), will obligate the second largest amount for R&D in FY 2005 at $28.9 billion, representing 27% of all federal R&D obligations. In contrast to DOD, HHS will allocate most of its R&D funding ($15.2 billion) for basic research. In FY 2005, HHS is expected to provide universities and colleges, the primary recipients of HHS funding, with $16.0 billion, which represents 67% of all federal R&D funds obligated to universities and colleges (table 4-7 ). HHS will provide 74% ($4.4 billion) of all federal R&D funds obligated to nonprofit institutions. Most of these institutions are large research hospitals such as Massachusetts General Hospital and the Dana-Farber Cancer Institute (NSF/SRS 2002). In 2005, competitive merit review processes with external (peer) evaluations were used to allocate 86% of HHS's basic and applied research funding.

National Aeronautics and Space Administration

The third largest agency in terms of R&D support is NASA, with R&D obligations expected to total $8.1 billion in FY 2005. Over one-third ($2.9 billion) of NASA's R&D activity is in development, much of which relies on industrial performers similar to those funded by DOD. However, unlike the industrial R&D funded by DOD, the majority (69%) of that funded by NASA supports research projects (basic and applied) as opposed to development. NASA is also the primary sponsor of R&D projects at nine federal facilities (including the Ames Research Center in California's Silicon Valley and the Marshall Space Flight Center in Huntsville, Alabama) and one FFRDC, the Jet Propulsion Laboratory, administered by the California Institute of Technology.

Department of Energy

Of the large R&D-funding agencies, the Department of Energy (DOE) relies the most on the R&D capabilities of FFRDCs. In FY 2005, DOE obligated 60% of its estimated $8 billion in R&D funding to FFRDCs. Of the 37 FFRDCs, DOE sponsored 16 and accounted for 59% of all federal R&D obligations to FFRDCs in FY 2005. Due to the scale and complexity of its research projects, most of DOE's research can only be performed in its intramural laboratories and FFRDCs. (See sidebar "Rationales for Federal Laboratories and FFRDCs.")

National Science Foundation

NSF is the federal government's primary source of funding for general S&E R&D and is expected to fund $3.8 billion of R&D in FY 2005. Of these funds, 94% are for basic research. NSF is the second largest federal source of R&D funds to universities and colleges; $3.2 billion is slated for academic researchers in FY 2005. In 2005, 73% of NSF's basic and applied research funding was allocated using competitive merit review processes with external (peer) evaluations. Most of its remaining research funding was allocated using competitive merit review processes with internal (program) evaluations.

Other Agencies

DOD, HHS, NASA, DOE, and NSF are expected to account for 94.1% of all federal R&D obligations in FY 2005 and slightly higher shares of federal obligations for basic research (94.5%) and development (98.8%). The remaining federal R&D obligations come from a variety of mission-oriented agencies such as the Department of Agriculture (USDA), the Department of Commerce (DOC), and the Department of the Interior (DOI). Unlike the larger R&D-funding agencies, USDA, DOC, and DOI direct most of their R&D funds to their own laboratories, which are run by the Agricultural Research Service, the National Institute for Standards and Technology (NIST), and the U.S. Geological Survey, respectively.

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Federally Funded R&D by Performer

Federal Funding to Academia

The federal government has historically been the primary source of R&D funding to universities and colleges, accounting for as much as two-thirds of all academic R&D funding in the early 1980s. (For more detailed information on academic R&D, see chapter 5). In 1955, obligations for academic R&D accounted for 7% of all federal R&D funding, or $0.75 billion in constant 2000 dollars. Fifty years later, R&D funding to academia represents 22% of all federal R&D obligations, or $21.65 billion in constant 2000 dollars. As figure 4-9 illustrates, funding to academia grew rapidly after 1998, the result of a successful bipartisan effort to double the budget of NIH from its 1998 level over 5 years.

Federal Funding to Industry

Since 1956, the federal government has obligated the largest share of its R&D funding to industry. Federal funding for this sector, largely for development projects, has experienced more variability over the past 50 years than for any other sector (figure 4-9 ). R&D obligations to industry grew rapidly in the 1960s and peaked at $42 billion in constant 2000 dollars as the government invested heavily in its space program. Following the successful Apollo 11 mission to the moon, R&D obligations to industry declined and did not experience another surge until over a decade later, when Cold War investments in military technology resulted in another period of growth. Similarly, military investments following the events of September 11, 2001, resulted in an influx of federal R&D funding to industry. After adjusting for inflation, federal R&D obligations to industry increased by more than 47% from 2001 to 2005. Beginning in 1989, the amount of federally funded R&D reported by industry began to diverge from the amount reported by the federal government. For details on this discrepancy, see sidebar "Tracking R&D: Gap Between Performer- and Source-Reported Expenditures."

Federal Intramural R&D

In FY 2005, obligations for federal intramural R&D totaled $24.8 billion. These funds supported R&D performed at federal laboratories as well as costs associated with the planning and administration of both intramural and extramural R&D projects. Among individual agencies, DOD continued to fund the most intramural R&D and is expected to account for almost half of all federal obligations for intramural R&D in FY 2005 (table 4-8 ). DOD's intramural R&D obligations are more than twice that of the second largest R&D-performing agency, HHS, which performs most of its intramural R&D at NIH in Maryland. Only two other agencies report intramural R&D obligations in excess of $1 billion in FY 2005, NASA and USDA.

Federally Funded Research and Development Center

FFRDCs are unique organizations that help the U.S. government meet special long-term research or development goals that cannot be met as effectively by inhouse or contractor resources. (See sidebar, "Rationales for Federal Laboratories and FFRDCs.") According to the Federal Register, an FFRDC is required "to operate in the public interest with objectivity and independence, to be free from organizational conflicts of interest, and to have full disclosure of its affairs to the sponsoring agency" (National Archives and Records Administration [NARA] 1990). First established during World War II to assist DOD and DOE with R&D on nuclear weapons, FFRDCs today perform R&D with both defense and civilian applications.

Of the 36 FFRDCs active in 2003, DOE sponsors 16, or more than any other agency.[27] These 16 FFRDCs performed a total of $9.2 billion of R&D in 2003, or more than three-quarters of that performed by all FFRDCs combined (appendix table 4-25 ). Four FFRDCs reported R&D expenditures of more than $1 billion in 2003—Los Alamos National Laboratory, Sandia National Laboratories, Jet Propulsion Laboratory, and Lawrence Livermore National Laboratory—accounting for over half of all FFRDC R&D expenditures.

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Federal Research Funding by Field

Federal agencies fund research in a wide range of S&E fields, from aeronautical engineering to sociology. The relative amount of research funding differs by field, as do trends in funding over time. According to preliminary estimates, federal obligations for research (excluding development) totaled $54.7 billion in FY 2005. Life sciences received the largest portion of this funding (54%, or $29.7 billion), followed by engineering (17%), physical sciences (10%), environmental sciences (7%), and mathematics and computer sciences (5%) (figure 4-11 ). Social sciences, psychology, and all other sciences accounted for the remainder.

HHS, primarily through NIH, provided the largest share (53%) of all federal research obligations in FY 2005, with most of its obligations funding medical and other related life sciences. The next four largest federal agencies in terms of research funding in FY 2005 were DOE (11%), DOD (10%), NASA (10%), and NSF (7%). DOE provides substantial funding for research in the physical sciences ($2.3 billion) and engineering ($2.0 billion). DOD's research funding is focused on engineering ($3.0 billion) and on mathematics and computer sciences ($0.8 billion). NASA's research funding also emphasizes engineering ($2.4 billion), followed by environmental sciences ($1.2 billion) and physical sciences ($1.1 billion). NSF, whose mission is to "promote the progress of science," has a more balanced research portfolio, contributing between $0.6 and $0.8 billion to researchers in each of the following groups of fields: mathematics and computer sciences, physical sciences, environmental sciences, engineering, and life sciences.

Federal obligations for research have grown at different rates for different S&E fields, reflecting changes in perceived public needs in those fields, changes in the national resources (e.g., scientists, equipment, and facilities) that have been built up in those fields over time, as well as differences in scientific opportunities across fields. Over the period 1984–2005, total federal research obligations grew, on average, 3.9% per year in real terms, from $22.2 billion in 2000 dollars to $49.5 billion in 2000 dollars. The groups of fields that experienced higher-than-average growth over this period were mathematics and computer sciences (6.7% per year in real terms), life sciences (5.7%), and psychology (6.7%) (appendix table 4-32 ). Funding for the remaining groups of fields also grew at a faster rate than inflation over this period: environmental sciences (3.0%), engineering (2.1%), social sciences (2.0%), and physical sciences (0.5%).

Caution should be employed when examining trends in federal support for more detailed S&E fields than those presented above because federal agencies classify a significant amount of R&D only by major S&E field, such as life sciences, physical sciences, or social sciences. In FY 2003, for example, 15% of the federal research obligations classified by major S&E field were not subdivided into detailed fields. This was less pronounced in physical sciences and in mathematics and computer sciences, in which all but 9% of the research dollars were subdivided. It was most pronounced in engineering and social sciences, in which, respectively, 35% and 62% of federal research obligations were not subdivided into detailed fields (appendix table 4-32 ).

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Federal R&D Budget by National Objective

Before any agency can obligate funds for R&D, it must first have budget authority from Congress for such activity. In the president's FY 2006 budget submission to Congress, the proposed total federal budget authority for R&D is $127.5 billion. Adjusting for inflation, this amount is a 2% decline from the prior year's budget. This decline follows a 5-year period of increasing inflation-adjusted federal R&D budgets. Although R&D tends to be a popular budgetary item, the growing federal budget deficit may hamper future growth in federal R&D.

To assist Congress and the president in evaluating and adjusting the federal budget, OMB requests agencies to allocate their budget requests into specific categories called budget functions. These budget functions represent a wide range of national objectives the government aims to advance, from national defense to health to transportation. Changing trends in federal R&D budget authority by budget function tend to reflect shifts in presidential and congressional priorities (see sidebar "Federal R&D Initiatives").

Defense-Related R&D

The largest R&D budget function in the FY 2006 budget is defense, with a proposed budget authority of $74.8 billion, or 59% of the entire federal R&D budget. In 1980 the federal budget authority for defense-related R&D was roughly equal to that for nondefense R&D, but by 1985 defense R&D had grown to more than double nondefense R&D (figure 4-12 ). The gap between the defense and nondefense R&D budgets shrank almost every year after 1986 until 2001, when the defense budget function represented 53% of the federal R&D budget. The terrorist attacks of September 11, 2001, reversed this trend, and the annual federal defense R&D budget grew by $29 billion over the next 5 years.

As described earlier, the majority of defense-related R&D goes toward the development of new and improved military technology, from weapons systems to communication technology. In FY 2006, DOD requested research, development, testing, and evaluation budgets in excess of $1 billion for four systems (US DOD 2005):

• Missile Defense ($8.1 billion): "A multilayer, multifaceted program designed to protect the United States, our Allies and deployed forces from missile attack."
  
  
• Joint Strike Fighter ($4.9 billion) : "The Joint Strike Fighter (JSF) is the next-generation strike fighter for the Air Force, Marine Corps, Navy, and U.S. allies."
  
  
• Future Combat System ($3.4 billion): "The FCS [Future Combat System] R&D program will develop network centric concepts for a multi-mission combat system that will be overwhelmingly lethal, strategically deployable, self-sustaining and highly survivable in combat through the use of an ensemble of manned and unmanned ground and air platforms."
  
  
• DD(X) Destroyer ($1.1 billion): "DD(X) will be an optimally crewed, multi-mission surface combatant designed to fulfill volume firepower and precision strike requirements."

Civilian-Related R&D

R&D accounts for 13.3% of the FY 2006 federal non-defense discretionary budget authority of $398.5 billion.[28] Although this is less than that reserved for defense activities (16.9% of the $441.8 billion discretionary budget authority in FY 2006), over 90% of federal basic research funding is for nondefense budget functions, accounting for a large part of the budgets of agencies with nondefense missions such as general science (NSF), health (NIH), and space research and technology (NASA) (table 4-9 ; appendix table 4-27 ).

The most dramatic change in national R&D priorities over the past 25 years has been the growing importance of health-related R&D. As illustrated in figure 4-12 , health-related R&D rose from representing 25% of the federal non-defense R&D budget allocation in FY 1980 to 55% in FY 2006. Most of this growth occurred after 1998, when NIH's budget was set on a pace to double by 2003 (Meeks 2002).

The budget allocation for space-related R&D peaked in the 1960s, during the height of the nation's efforts to surpass the Soviet Union in space exploration. Since the loss of the Space Shuttle Columbia and its crew of seven on 1 February 2003, manned space missions have been curtailed. Nonetheless, the proportion of the federal R&D budget for space research is slightly higher in 2006 (15.3%) than in 2003 (14.9%). In the president's FY 2006 budget, 54% of NASA's $16.5 billion discretionary budget was allocated for R&D.

Compared with that of health-related R&D, the budget allocation for general science R&D has grown relatively little in the past 25 years. In fact, the growth in general science R&D is more the result of a reclassification of several DOE programs from energy to general science in FY 1998 than the result of increased budget allocations (figure 4-12 ). The formation of the Department of Homeland Security (DHS) and the coincident reclassification of much of its formerly civilian R&D activities as defense R&D is a more recent example of how R&D budget function classifications can change when the mission or focus of funding agencies changes.

Federal S&T Budget

Alternative concepts have been used to isolate and describe fractions of federal support that could be associated with scientific achievement and technological progress. In a 1995 report, a National Academy of Sciences (NAS) committee proposed an alternative method of measuring the federal government's S&T investment (NAS 1995). According to the committee members, this approach, called the federal science and technology (FS&T) budget, might provide a better way to track and evaluate trends in public investment in R&D. The FS&T concept differed from the traditional federal R&D data definitions used earlier in this section in that it did not include major systems development supported by DOD and DOE, and it contained not only research but also some development and some R&D plant.

Beginning with the FY 2000 budget, OMB has presented its concept for an FS&T budget (figure 4-13 ). Whereas the NAS FS&T compilation included only R&D, OMB's FS&T budget was compiled from easily tracked programs and included some non-R&D programs, such as NSF education programs and staff salaries at NIH and NSF.

In the 2006 Budget of the United States, OMB's FS&T budget is less than half the total federal R&D budget because it excludes funding for defense development, testing, and evaluation. It includes nearly all budgeted federal support for basic research in FY 2004, more than 80% of federally supported applied research, and about half of federally supported nondefense development.

As shown in figure 4-14 , federal R&D in the 2006 budget proposal, which includes expenditures on facilities and equipment, would reach a level of $132 billion. Of this amount, $55 billion would be devoted to basic and applied research alone. The FS&T budget would reach $61 billion and would include most of the research budget. However, differences in the definition of research and FS&T imply that not all research would be included in FS&T and vice versa. Moreover, a small proportion (10%) of FS&T funds would fall outside the traditional definition of federal R&D spending.

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Federal R&E Tax Credit

Background

One of the better-known indirect federal incentives for fostering industrial R&D is the research and experimentation (R&E) tax credit.[29] The traditional justification for incentives for research is that results from these activities, especially more basic or long-term research, are often hard to capture privately because others might benefit directly or indirectly from them. Therefore, businesses might engage in levels of research below those that would be beneficial to the nation as a whole. Across advanced economies, R&D tax credits vary in terms of how they are structured or targeted, their effect on public budgets, and their effectiveness in stimulating innovation (Bloom, Griffith, and Van Reenan 2002; OECD 2003).[30]

The federal R&E tax credit was established by the Economic Recovery Tax Act of 1981, one of several policy tools put in place in the 1980s to address perceived problems in the competitive position of U.S. companies (Guenther 2005). The credit is subject to periodic extensions given its temporary status. It was renewed most recently by the Working Families Tax Relief Act of 2004 through 31 December 2005.[31]

The credit is designed to stimulate company R&D over time by reducing after-tax costs. Specifically, companies that qualify for the credit can deduct or subtract from corporate income taxes an amount equal to 20% of qualified research expenses above a base amount.[32] For established companies, the base amount depends on historical expenses over a statutory base period relative to gross receipts, whereas startup companies follow other provisions. An alternative R&E credit has been available since 1996. This credit has a lower base amount and a maximum statutory rate of 3.75%. The alternative credit benefits established companies that have smaller annual increases relative to their base period (Hall 2001). Companies may select only one of these two credits on a permanent basis, unless the Internal Revenue Service (IRS) authorizes a change. Both types of R&E credit include provisions for basic research payments to qualified universities or scientific research organizations.

Tax Credit Claims

According to data from the IRS' Statistics of Income (SOI), R&E tax credit claims reached an estimated $6.4 billion in 2001 ($6.2 billion in constant or inflation-adjusted dollars), compared with the all-time high of $7.1 billion in 2000 (table 4-10 ).[33] From 1990 to 2001, the annual dollar amount of R&E credit claims grew twice as fast as industry-funded R&D, after adjusting for inflation (NSF/SRS 2005), but growth in credit claims varied throughout the decade. From 1990 to 1996, companies claimed between $1.5 billion and $2.5 billion in R&E credits annually; since then, annual R&E credits have exceeded $4 billion (table 4-10 ). However, R&E tax credit claims still accounted for less than 4% of industry-funded R&D expenditures as of 2001 (figure 4-15 ).

Data are available on the industry classification of companies that claim the R&E tax credit for 1998–2001 using the new North American Industry Classification System (NAICS) -(appendix table 4-33 ). Since 1998, corporate tax returns classified in five industries accounted for 80% or more of R&E credit claims. In 2001, the top five industries accounted for 80% of credit claims ($5.1 billion of the $6.4 billion):

• Computer and electronic products (26%)
• Information, including software (16%)
• Chemicals, including pharmaceuticals and medicines (16%)
• Transportation equipment, including motor vehicles and aerospace (12%)
• Professional, scientific, and technical services, including computer services and R&D services (10%)

The number of corporate tax returns claiming the R&E tax credit grew at a slower rate than their dollar R&E credit claims, fluctuating between 8,000 and 10,000 tax returns over most of the 1990s (table 4-10 ). In 2001, companies in the professional, scientific, and technical services industry filed more corporate tax returns claiming the R&E tax credit than did any other industry. That industry represented about 28% of all returns claiming the credit, followed by computer and electronic products and information, each with about 15% (figure 4-16 ).

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National Science Foundation, Division of Science Resources Statistics
Science and Engineering Indicators 2006
Arlington, VA (NSB 06-01) [February 2006]