Federal R&D

In the president's 2008 budget submission, the federal government is slated to invest $138 billion in R&D, amounting to 12.8% of its discretionary budget (i.e., that part of the annual federal budget that the president proposes and Congress debates and sets). The government supports S&T through a number of policy measures, the most direct of which is the conduct and funding of R&D that would not, or could not, be conducted or financed in the private sector. This section presents data on such R&D activities, on the government's contribution to the U.S. R&D infrastructure, and on federal and state R&D tax credits (an indirect means of stimulating R&D in the private sector).

R&D by Federal Agency

Federal agencies are expected to obligate $113 billion for R&D support in FY 2007 (table 4-7table.). Although more than 25 agencies report R&D obligations, only 7 report expected R&D obligations of more than $1 billion in FY 2007. Together, these agencies account for 96% of total federal R&D. These agencies vary considerably in terms of their R&D funding, reflecting the unique mission, history, and culture of each.

Department of Defense

According to preliminary data, DOD will obligate $56 billion for R&D support in FY 2007. DOD funds more R&D than any other federal agency, representing half of all federal R&D obligations. Of these funds, 89% ($50 billion) will be spent on development (figure 4-6figure.). Most of the development funded by DOD is classified as "major systems development" ($44 billion), representing the cost of developing, testing, and evaluating combat systems. Industrial firms are expected to perform 74% of DOD-funded R&D in FY 2007. DOD accounts for more than 84% of all federal R&D obligations to industry in FY 2007. Federal intramural R&D and R&D performed by FFRDCs account for most of DOD's remaining R&D activity and represent 25% of its FY 2007 total.

Department of Health and Human Services

The Department of Health and Human Services (HHS), the primary source of federal health-related R&D funding (largely through its National Institutes of Health [NIH]), will obligate the second largest amount for R&D in FY 2007 at $29 billion, representing 26% of all federal R&D obligations. In contrast to DOD, HHS will allocate most of its R&D funding ($16 billion) for basic research. In FY 2007, HHS is expected to provide universities and colleges, the primary recipients of HHS funding, with $16 billion, which represents 65% of all federal R&D funds obligated to universities and colleges (table 4-8table.). HHS will provide 75% ($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 2007c).

National Aeronautics and Space Administration

The third largest agency in terms of R&D support is NASA, with R&D obligations expected to reach more than $8 billion in FY 2007. Almost half ($4 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 (55%) 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, DOE invests the most resources in FFRDCs. In FY 2007, DOE obligated 67% of its estimated $8 billion in R&D funding to these organizations. Of the 37 FFRDCs, DOE sponsored 16 and accounted for more than half of all federal R&D obligations to FFRDCs in FY 2007. Much of DOE's research requires specialized equipment and facilities that are only available at its intramural laboratories and FFRDCs. (See the section on FFRDCs later in this chapter.)

National Science Foundation

NSF is the federal government's primary source of funding for general S&E research and is expected to fund $4 billion of R&D in FY 2007. Of these funds, 91% are for basic research. Unlike many other federal agencies, NSF does not operate any of its own laboratories, but instead supports scientists and engineers through their home institutions. For the most part, these home institutions are universities and colleges; NSF is the second largest federal source of R&D funds to universities and colleges and is expected to invest more than $3 billion in academic research in FY 2007.

Department of Agriculture

USDA is expected to fund almost $2 billion of R&D in FY 2007, with most of this (69%) supporting USDA intramural R&D. Although USDA focuses most of its R&D in the life sciences, it is also one of the largest funding agencies for research in the social sciences, predominantly agricultural economics.

Department of Homeland Security

In FY 2007, the Department of Homeland Security (DHS) is expected to fund approximately $1 billion in R&D. DHS conducts and funds research in various areas but focuses significant resources on countering threats of catastrophic terrorism such as weapons of mass destruction. Most of this R&D is either conducted in DHS laboratories or under contract by industrial firms and FFRDCs. DHS also has established a grant-giving agency, Homeland Security Advanced Research Project Agency, modeled in part on the Defense Advanced Research Project Agency.

Other Agencies

Of the remaining R&D-funding federal agencies, 10 are expected to fund between $100 million and $1 billion of R&D in FY 2007. The largest of these agencies in terms of R&D funding are the Department of Commerce (DOC), the Department of the Interior (DOI), and the Environmental Protection Agency (EPA). Unlike most of the larger R&D-funding agencies, DOC, DOI, and EPA direct most of their R&D funds to their own laboratories, which are run by the National Institute of Standards and Technology (NIST), the U.S. Geological Survey, and the EPA Office of Research and Development, respectively.

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 FY 1955, obligations for academic R&D accounted for 7% of all federal R&D funding, or $0.8 billion in constant 2000 dollars. In FY 2007, R&D funding to academia represents an estimated 22% of all federal R&D obligations, or $21 billion in constant 2000 dollars. As figure 4-7figure. illustrates, funding to academia grew rapidly after FY 1998, the result of a successful bipartisan effort to double the budget of NIH from its FY 1998 level over 5 years. After FY 2004 however, federal R&D obligations to universities and colleges failed to keep pace with inflation.

Federal Funding to Industry

Since FY 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 4-7figure.). 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 more than 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 48% between FY 2001 and 2005. Beginning in FY 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 2007, obligations for federal intramural R&D totaled almost $25 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 2007 (table 4-8table.). 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 of more than $1 billion in FY 2007, NASA and USDA.

Federally Funded Research and Development Centers

FFRDCs are unique organizations that help the U.S. government meet "special long-term research or development needs that cannot be met as effectively by existing in-house or contractor resources." According to the Federal Acquisition Regulations (35.017), 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." 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 across a broad range of S&E fields.

Of the 37 FFRDCs active in 2005, DOE sponsors 16, more than any other agency. These 16 organizations performed almost $10 billion of R&D in FY 2005, three-quarters of that performed by all FFRDCs combined (appendix table 4-25Excel.). Four reported R&D expenditures of more than $1 billion in FY 2005: Los Alamos National Laboratory, Sandia National Laboratory, Jet Propulsion Laboratory, and Lawrence Livermore National Laboratory. Together, these four laboratories account for more than half of all FFRDC R&D expenditures. Los Alamos National Laboratory and the Lawrence Livermore National Laboratory are the only two laboratories in the United States where research on the nation's nuclear stockpile is conducted. See sidebar, "Federal R&D Infrastructure," for more information on FFRDCs' and other federal facilities' contributions to the U.S. R&D system.

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 (basic plus applied) research funding differs by field, as do trends in funding over time. According to preliminary estimates, federal obligations for research (excluding development) will total $55 billion in FY 2007 (see "Definitions of R&D" sidebar earlier in this chapter). Half of this funding, almost $28 billion, supports research in the life sciences. The next largest fields in terms of their share of expected federal research obligations in FY 2007 are engineering (17%), physical sciences (10%), environmental sciences (7%), and mathematics and computer sciences (6%) (figure 4-8figure.). The balance of federal research obligations ($5 billion) supports the social sciences, psychology, and all other sciences.

HHS, primarily through NIH, provides the largest share (52%) of all federal research obligations in FY 2007, 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 2007 are DOD (12%), DOE (11%), NASA (7%), and NSF (7%). DOD's research funding is focused on engineering ($3.6 billion) and on mathematics and computer sciences ($1.0 billion). DOE provides substantial funding for research in the physical sciences ($2.4 billion) and engineering ($2.0 billion). NASA's research funding also emphasizes engineering ($1.5 billion), followed by physical sciences ($1.1 billion) and environmental sciences ($1.0 billion). NSF, whose mission is to "promote the progress of science," has a relatively balanced research portfolio, contributing between $0.5 and $0.9 billion to researchers in each of the following fields: mathematics and computer sciences, physical sciences, engineering environmental sciences, 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, and differences in scientific opportunities across fields. Over the period 1986–2007, total federal research obligations grew on average 3.4% per year in real terms, from $23 billion in 2000 dollars to $47 billion in 2000 dollars. The fields that experienced higher-than-average growth during this period were mathematics and computer sciences (5.6% per year in real terms), life sciences (4.6%), and psychology (6.1%) (appendix table 4-32Excel.). Funding for the remaining fields also grew at a faster rate than inflation over this period: social sciences (2.7%), engineering (2.0%), environmental sciences (1.9%), and physical sciences (0.5%).

Caution should be used 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 2005, for example, 1% 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 mathematics and computer sciences, in which all but 6% of the research dollars were subdivided. It was most pronounced in social sciences and psychology, in which, respectively, 69% and 97% of federal research obligations were not subdivided into detailed fields (appendix table 4-32Excel.).

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 2008 budget submission to Congress, the proposed total federal budget authority for R&D is $138 billion. Adjusting for inflation, this amount is a 1% decline from the previous 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 debt may hamper future growth in federal R&D.

To assist Congress and the president in evaluating and adjusting the federal budget, the Office of Management and 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 (see sidebar, "Federal R&D Initiatives").

Defense-Related R&D

The largest R&D budget function in the FY 2008 budget is defense, with a proposed budget authority of $82 billion, or 60% of the entire federal R&D budget. (DOD requested $78 billion for its research, development, testing, and evaluation budget; the remainder of defense-related R&D is funded by DOE and HHS.) 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 4-11figure.). 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 an estimated $36 billion over the next 7 years.

Civilian-Related R&D

R&D accounts for 13.1% ($56 billion) of the FY 2008 federal nondefense discretionary budget authority of $428 billion, or slightly more than the R&D share reserved for defense activities (12.7% of the $647 billion discretionary defense budget authority in FY 2008). Almost 95% 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 4-9table.; appendix table 4-27Excel.). Over the last several years, however, the budget authority for basic research has been rather flat. In FY 2002 that budget authority was approximately $23 billion (in constant 2000 dollars), and the same amount has been proposed for FY 2008.

The most dramatic change in national R&D priorities during the past 25 years has been the large rise in health-related R&D. As illustrated in figure 4-11figure., health-related R&D rose from representing 25% of the federal nondefense R&D budget allocation in FY 1980 to a high of 55% in FY 2005. Most of this growth occurred after 1998, when NIH's budget was set on a pace to double by 2003 (NSF/SRS 2002a). Growth in health-related R&D has since slowed considerably and accounted for 52% of the proposed FY 2008 nondefense R&D budget.

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 were curtailed. Nonetheless, the proportion of the proposed federal nondefense R&D budget for space research was higher in FY 2008 (17%) than in FY 2003 (15%). In the president's FY 2008 budget, 58% of NASA's $17 billion discretionary budget was allocated for R&D. This space R&D total is higher (in constant dollars) than at any time since FY 1999.

Compared with that of health-related R&D, the budget allocation for general science R&D has grown relatively little during the past 25 years. The growth that has occurred 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 it is the result of increased budget allocations (figure 4-11figure.).

Federal and State R&D Tax Credits


Governments have used multiple policy tools to foster R&D in diverse industries, technologies, and innovation environments (Martin and Scott 2000; Tassey 1996). Fiscal policy tools include direct funding (as discussed earlier in this chapter) and indirect incentives such as tax relief.[19] Tax relief may take the form of a tax allowance, exemption or deduction (a reduction in taxable income), or a tax credit (a reduction in tax liability). The United States offers both types of incentives, namely a deduction for qualified R&D under U.S. Internal Revenue Code (C.F.R. Title 26) Section 174 and a tax credit under Section 41 (Guenther 2006; Hall 2001). R&D tax incentives in advanced economies 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 Reenen 2002; OECD 2003). This section focuses on business R&D tax credits at the federal and state levels.

The federal research and experimentation (R&E) tax credit was established by the Economic Recovery Tax Act of 1981. Given its temporary status, it is subject to periodic extensions, and it was last renewed by the Tax Relief and Health Care Act of 2006 (Public Law 109–432) through 31 December 2007.[20] The Bush administration has proposed making the R&E tax credit permanent (OMB 2007).

Under the federal R&E tax credit, companies can take a 20% credit for qualified research above a base amount for activities undertaken in the United States.[21] For most companies, the base amount is determined by multiplying R&D-to-sales ratio by the average gross receipts for the previous 4 years. Currently, the reference period for R&D-to-sales ratio is fixed as the average from 1984 to 1988 (start-up companies follow different provisions). Thus, the credit is characterized as a fixed-base incremental credit (Hall 2001; Wilson 2007). Companies, however, benefit by less than the statutory credit rate of 20%, since benefits from the credit are taxable.[22]

An alternative R&E tax credit has been available since 1996 (Small Business Protection Act, Public Law 104–188). The 2006 Act (Public Law 109–432), signed into law in December 2006, not only extended the research credit for 2 years—2006 (retroactively) and 2007—but also increased the rates for the alternative credit for 2007. In addition, it created a new, simplified alternative credit beginning in 2007. Companies may select only one of these credit configurations on a permanent basis, unless the Internal Revenue Service (IRS) authorizes a change. A 20% credit with a separate threshold is provided for payments to universities for basic research.

Federal Corporate Tax Credit Claims

R&E tax credit claims reached an estimated $5.5 billion in 2003 ($5.2 billion in constant, or inflation-adjusted, dollars), involving just under 10,400 corporate tax returns, compared with the all-time high of $7.1 billion in 2000 (table 4-10table.), according to IRS Statistics of Income Division (SOI) estimates.[23] Even at their 2000 peak, R&E tax credit claims accounted for less than 4% of industry-funded R&D expenditures (figure 4-12figure.). Since 1998, corporate tax returns classified in five North American Industry Classification System (NAICS) industries accounted for approximately 80% of R&E credit claims. In 2003, the top five industries accounted for a total of $4.2 billion or 77% of credit claims:

  • Computer and electronic products (21%)
  • Chemicals, including pharmaceuticals and medicines (18%)
  • Transportation equipment, including motor vehicles and aerospace (16%)
  • Information, including software (12%)
  • Professional, scientific, and technical services, including computer services and R&D services (10%)

In 2003, companies classified in the professional, scientific, and technical services industry represented one-third of all corporate returns claiming the R&E tax credit, followed by computer and electronic products and information, each with about 15%. Consequently, among the top five industries listed above, professional, scientific, and technical services had the lowest average claims per return ($15.9 million) in 2003, compared with an average of $52.9 million per return overall.[24]

State Tax Credits

At least 32 states offered credits for company-funded R&D (table 4-11table.) in 2006, according to Wilson (2007). The first such credit was enacted by Minnesota in 1982 only a year after the federal R&E credit was enacted. Since then, the number of states offering a research credit has increased gradually (figure 4-13figure.).

More than half of these states' research credits (19 of 32) mimic the structure of the federal credit, namely, an incremental credit with a fixed base (table 4-11table.). Another 10 states offer an incremental credit with a moving average (much like the earlier version of the federal credit). Three states (Connecticut, Hawaii, and West Virginia) have a nonincremental credit, that is, the credit applies to all qualified research. These counts do not include narrowly targeted credits (either by technology or geographically within the state) or credits with a cap.[25]

In a study attempting to measure the impact of states' research credits, Wilson (2007) was able to estimate increases in within-state R&D. At the same time, however, estimated effects appear to come from shifts in other states' R&D, raising questions about the aggregate effect of these state R&D incentives. Further empirical research on these issues is warranted given the recent enactment of some of these credits.


[19] Both tax incentives and direct federal funding represent federal expenses. In terms of the budget, tax incentives generate tax expenditures and government revenue losses because of tax exclusions or deductions. For estimates of tax expenditures arising from the R&E tax credit, see OMB (2007).

[20] The federal credit was not in place for activities conducted from July 1995 to June 1996.

[21] For tax purposes, R&D expenses are restricted to the somewhat narrower concept of R&E expenditures (Internal Revenue Code Section 174; see also NSF/SRS [2006b]). Such expenditures are limited to experimental or laboratory costs aimed at the development or improvement of a product in connection with the taxpayer's business. Furthermore, the R&E tax-credit applies to a subset of R&E expenses based on additional statutory requirements (Internal Revenue Code Section 41).

[22] The credit was not taxable from 1981 to 1988; 50% taxable in 1989; and fully taxable since 1990.

[23] Not all R&E claims are allowed. For example, there are limitations on the reduction of total tax liabilities. Data exclude IRS tax forms 1120S (S corporations), 1120-REIT (real estate investment trusts), and 1120-RIC (regulated investment companies).

[24] For more information about the 2003 research credit, see tables in IRS (2007). These tables have additional details based on IRS tax form 4765. The return counts obtained from SOI and used in the text represent returns claiming "current year credit for increasing research" (i.e., the number of returns with a non-zero amount in line 41 of IRS tax form 4765).

[25] Differences in the structure of tax credits are important in determining effective rates (compared with statutory rates).

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