WITH SO MANY VARIABLES IN R&D PLANNING, CONSISTANCY IN GOVERNMENT TAX POLICY WOULD PERMIT A LEVEL OF CONFIDENCE FOR LONG TERM INVESTMENT DECISIONS.

DELETION OF THIS SUNSET PROVISION WILL GIVE THE PRIVATE SECTOR AMPLE PLANNING TIME FOR FINANCIAL COMMITMENT AND THE OPPORTUNITY FOR THE CONGRESS TO EVALUATE THE EFFECTIVENESS OF THIS TAX POLICY.

AGAIN, MANY THANKS FOR THE OPPORTUNITY TO APPEAR BEFORE THIS

COMMITTEE TODAY TO EXPRESS MY VIEWS ON THIS NECESSARY LEGISLATION. I URGE ITS PASSAGE.

Congressman ZSCHAU. Thank you very much. I will just comment briefly about the contents of the prepared statement.

I think we are finding, happily, in Washington these days enormous interest in promoting high technology. The President has made a commitment to maintain our technological leadership. There are a great many bills that have been introduced to improve high technology. I think it is because of the performance of the industry in terms of job creation, exports, productivity improvement, that this interest in high technology has grown.

The question that has to be asked is, "What is the proper role for the Federal Government in promoting high technology?" There are some who have proposed that we should have some sort of Government planning board to target specific technologies or industries or companies or products and allocate resources, as they imagine MITI, the Ministry of International Trade and Industry, in Japan, operates.

My feeling is that sort of central planning approach is inappropriate and would be doomed to failure. Rather than targeting industries or technologies, what we should be doing is targeting the process-the process of innovation. That is, Government should be creating the environment in which it is likely that innovation and technological advances will flourish.

My assessment of that process is based on not only my own experience in the high technology industry, but also experiences of others in my district, the Silicon Valley, which has some 700 high technology companies in and around it.

The process of innovation requires four prerequisites or conditions. Proper Government policy should make sure that those conditions are maintained.

No. 1, we need a strong commitment to basic research, the foundation for future products. No. 2, we need incentives for innovators, entrepreneurs and investors to take the kind of risks that are inherent in high technology. No. 3, we need an adequate supply of trained technical people to do the work. And, No. 4, we need adequate opportunities, not only domestically but foreign opportunities, to market our products.

The bills that are before this committee and which are the subject matter of this hearing focus on two of those elements. One is the incentive for risk taking, and the second is the availability of trained technical people. I would like to comment on each of them briefly.

Senate bill 738 would make permanent the R&D tax credit. I would like to associate myself with the comment of my colleague from Massachusetts, Congressman Shannon. I believe that he was right on target. This is an appropriate type of incentive for companies; it has demonstrated at least early signs of working, but it can't work if it is only temporary. The planning cycle for R&D projects is far longer than 2 years. The uncertainty created by the sunset provision currently in the law, I believe, is limiting the effectiveness of the tax credit. I strongly urge that the tax credit be made permanent.

I think that it is important to point out that the tax credit would be in effect in any case through 1985, so that the short-term revenue loss would be reasonably small. However, the effect on longterm R&D would in the meantime be taking place if we made it permanent now. I think that is a good trade-off when we have to be concerned about tax revenues in this period of high budget deficits. I think also, although it is not part of S. 738, that this would be an appropriate time to review the tax credit on other grounds. There are other improvements that might be made. One of the current controversies regarding the credit is how software should be treated. Regulations have been written that may define software too narrowly. Software is becoming a major part of any computer systems design, and if the regulations are too narrow, it may be necessary to clarify the legislative intent through a new piece of legislation.

In addition, the tax credit currently does not enable the small companies, the start up companies, to take full advantage of the credit. It is assumed for the purpose of calculating the increase in R&D expenditures that the base period level above which one calculates the increase is no less than 50 percent of the current years expenditures. Large companies don't grow at a rate of more than 100 percent in R&D per year, but small companies, just starting out, could be growing much faster. Under the current law, the small companies could not take full advantage of the tax credit. These small companies, I feel, are the ones that are most likely to generate new ideas. That is another reason why we should examine the specific provisions of the tax credit.

Moving on to S. 1194 and S. 1195, I just want to commend you, Mr. Chairman, and Senator Bentsen for your leadership in offering these bills directed at what I consider to be the key problem facing the high technology industries these days. The scarcity of trained technical people. We have in the electronics industry, for example, studies that indicate that there will be a shortfall of about 16,000 engineers per year throughout the mid-1980's. It is well-known that Japan, a country with half our population, turns out more engineers per year than we do.

This is, in my opinion, a result of a lack of capacity at college and university engineering schools. It is a financial problem. It takes money in order to attract faculty. We currently have about

2,000 faculty openings in our colleges and university engineering departments that are not filled. It also takes money in order to provide equipment for those people.

I believe that instead of this being a purely Government problem, private industry has an important role to play. After all, private industry generates the requirements for these engineers. Companies are very interested in getting the engineers trained. Already, we have seen companies finding ways to make contributions to colleges and universities for engineering department capacity increases. However, I think that Government also has a role to play by providing some incentives. The tax incentives in S. 1194 and S. 1195 should result in more money being directed toward supplying the equipment necessary to train engineers and science and mathematics majors in colleges, and it should also result in money to pay faculty and provide loans for students. I think that those bills have a nice balance of incentives with safeguards in them so that abuses won't occur. By using the tax incentive concept, we are encouraging private industry to find those areas where money can be best used without setting up a bureauracy in the Government that would be necessary to approve and monitor the giving of grants.

These two types of legislation-S. 738, to make permanent the effective incentive for research and development and the Senate bills providing incentives for contributions to colleges and universities for educational purposes-are great steps forward. They are consistent with what I envision to be the proper role of government: To create the environment in which high technology and innovation can flourish.

I appreciate the chance to appear before you, Mr. Chairman, and I would be happy to answer any questions you might have.

Senator DANFORTH. Congressman, thank you very much for an extraordinarily thoughtful, though provoking presentation. I think that your comments on targeting are exactly right. The notion that the United States is going to follow the Japanese model is, I think, very farfetched. If we were to target industries in this country, more likely we would be targeting those industries with the most political effect, and we would end up bailing out industries rather than targeting the small but promising growth industries. And I think that this idea of targeting a process rather than specific industries is much more in keeping with our way of doing things and offers much more promise.

With respect to S. 1194 and S. 1195, the origin of the whole concept of R&D tax credits and tax credits for businesses, contributing to universities for research, and so forth, came out of a discussion I happened to be in on one day, very informal, and the two participants, other than myself, were a very well-known scientist and a university president. The scientist was in the private sector. And one thing that they agreed on was the importance of attempting to build some relationship between industry and academia with respect to research and science. They felt that that was one of the most important contributions that could be made: to have industry more supportive of education and to have a relationship between scientists in academia and in the private sector. And that was really, in my own mind, the origin of my thinking on the kind of bill that S. 1194 turned into, especially with respect to the higher

education portion of that bill. And I think that you have pointed out that effect also in your testimony. And I appreciate your comments.

Congressman ZSCHAU. If I may, let me just add a comment to what you said. There are many people who have asked me why is it that there are so many high technology companies in the Silicon Valley area. I think part of the answer is due to the fact that the dean of the engineering school in times past, Dean Termon, at Stanford University, had the concept of a close relationship between the academic operations in his department and industry. He fostered a close communication. There is a lot of interaction that takes place today. The fact the that interaction was not only tolerated but encouraged helped to promote the phenomenon that we now see in Silicon Valley.

Senator DANFORTH. That is undoubtedly true in Silicon Valley. I would guess that it would also be true wherever there are concentrations in this country of high tech industries, that there is in very close geographical proximity a major research university, and that there is an interchange between the two. And this bill is designed to encourage that kind of interaction.

Senator Heinz?

Senator HEINZ. No questions, Mr. Chairman.

Senator DANFORTH. Thank you very much, Congressman. Congressman ZSCHAU. Thank you very much, Mr. Chairman. Senator HEINZ. Mr. Chairman, I would like to make an observation if I may before our next distinguished witness, Buck Chapoton, makes his presentation, which is this: The bills before us-your bill, Mr. Chairman, S. 738 and S. 1194, and Sentator Bentsen's bill, S. 1195-are all, in my judgment, very laudable bills. I support their goals; indeed, I have sponsored or cosponsored several of them. But I am concerned Mr. Chairman, about the fact that there are a number of basic industries-steel, chemical, mining, among them that simply are unable to take advantage of the research and development credits that were offered. There are profitable industries that can take advantage of them. But because of the way our tax code works, it is not possible for an industry that is not making money and paying taxes to take advantage of an investment tax credit or a research and development tax credit.

In the case of the steel industry, it lost $3 billion last year. Maybe it will come out even or a little bit ahead this year. But even if it does come out ahead this year, it has so many unexpired investment tax credits that the research and development credits proposed to be expended or expaned upon will be of little or no value to industries like the steel industry. It seems to me that our most troubled industries, industries which I know from personal discussions have many technological opportunities, not just to go to the next generation of technology but to go a generation beyond that generation, to leapfrog so-called advanced technology and become truly high tech industries, will not be able to do so under the legislation proposed before us.

Now I am aware that we have not in this committee been terribly enthusiastic about the refundability of tax credits, although I think we voted for them on tuitition-I think the committee approved them for tuition tax credits the other day. It seems to me

that we either have to make these research and development tax credits refundable or find an equivalent mechanism that will allow them to be of value to our most troubled industries that are able to move ahead to find research and development opportunities and to become once again the high tech industries that they were at the end of World War II, or even in some cases through the 1960's. It seems to me if we don't do that, we indeed, Mr. Chairman, are doing something that I know you don't want to do, which is to pick winners and losers.

Current law, as it stands, picks winners among only those who are currently ahead in the race, and it consigns not just to the back of the pack but to falling at the wayside during the course of the race industries that are not now but could be in a healthy financial position in the future. So I hope, Mr. Chairman, as we continue our deliberations here that we will take a careful look at how we can make it possible for industries that can and do have a future, if they are allowed to participate in the kinds of incentives that are contemplated by you, myself and others in this committee, how, in fact, we can accomplish that goal. I thank you, Mr. Chair

man.

Senator DANFORTH. Well, maybe Secretary Chapoton can help us think creatively on this. [Laughter.]

Senator HEINZ. That is why I waited for him to arrive, Mr. Chairman.

STATEMENT OF HON. JOHN E. CHAPOTON, ASSISTANT SECRETARY FOR TAX POLICY, DEPARTMENT OF THE TREASURY, WASHINGTON, D.C.

Mr. CHAPOTON. Thank you, Mr. Chairman. I have a quite lengthy statement. I will summarize it. I think I would like to spend most of my time on the S. 738, the proposal for a permanent extension of the tax credit for incremental research and development.

We do appreciate the opportunity to present our views to the subcommittee this morning. The administration strongly supports the objectives of the R&D credit. We believe the credit should be extended to enable taxpayers to plan their research and experimental activities with a certainty that the credit will be available, and we are supporting an extension of the credit for 3 years through December 31, 1988.

The effectiveness and efficiency of the credit is currently under review within the administration by an interagency working group. Our review thus far indicates that some modifications of the credit may be called for when the credit is extended. We would like to come forward at a later time to the subcommittee with specific recommendations for improving the credit.

Congress enacted the credit for R&D expenditures in order to encourage industry to undertake the risky research and experimental activities that may lead to productivity enhancing innovation. The need for such activities cannot be disputed: innovation is essential if the United States is to retain and improve its competitive position in the world economy.

To provide the greatest incentive, the credit must flow to those industries, and to particular taxpayers, that devote increasing