essential to their activities.

Indeed, a continuing commitment to R&E

is fundamental to their ability to open and enlarge markets, create meaningful employment, secure the defense, and achieve other useful

purposes.

U.S. R&E Performance /1

As to the U.S. R&E performance generally, with particular reference to the company-funded effort, National Science Foundation (NSF) surveys indicate that companies--which account for some 70 percent of the total U.S. R&E--have continued to expand their programs in real terms since 1980. However, the average annual rate of growth is expected to be less than three percent between 1980 and 1983, a rate of growth that is less than one-half the average rate of real growth--6.3 percent--that occurred during 1975 and 1980. The slowdown is attributed in part to economic uncertainties, lower profits, and higher real interest rates. Total U.S. R&E as a percentage of gross national product (GNP) in 1981 was approximately 2.4 percent and compares fairly well with other industrialized countries, other than the U.S.S.R. However, civilian U.S. R&E registered approximately 1.6 percent of GNP whereas West Germany and Japan--to cite two other significant trading nations-were at 2.2 percent and 1.9 percent, respectively.

1/

NSF uses the traditional phrase "research and development" (R&D), as compared to R&E, to describe investigative activity directed toward the creation of new or improved products or processes. Because the definition of R&D for statistical data collection purposes is similar to that of R&E, as used in the tax law, we employ the latter phrase (i.e., R&E) for convenience.

In the matter of full-time-equivalent R&E scientists and engineers as a percentage of the labor force, the U.S. record compares well with other nations. However, testimony received by the Subcommittee based on recent surveys indicates that certain countries (e.g., the U.S.S.R. and Japan) are producing many more engineering graduates annually per million of population than this country. Meanwhile, there is a large and growing gap between the demand for and supply of engineers in this country, partly due to the surging private sector need for technically trained people and to faculty and facility shortages in U.S. colleges and universities. Also, as noted in the recent report of the National Commission on Excellence in Education, our school system suffers from curriculum, facility, and other deficiencies, especially in

mathematics and the sciences.

Without reciting statistics at length, we believe it can be shown that the recent U.S. record in R&E and in scientific and engineering education leaves something to be desired. The sort of assistance embodied in the bills before the Subcommittee would involve relatively little revenue and a minimum of federal government intrusion. In our opinion, the benefits could be substantial in relation to the costs, and the bills under examination are well worth the Subcommittee's

attention.

MAPI Position, in Brief

Our position, in brief, is that the Subcommittee should report

S. 738 favorably without delay, and give similar consideration when time

:

permits to S. 1194, S. 1195, or legislation of like character. In our opinion, the R&E credit is likely to have beneficial effects over the long run for those companies with steady increases in their R&E effort, and we support an indefinite extension as well as the consideration of ways to increase its versatility. Also, we generally favor liberalized tax provisions to ease, through charitable deductions, the burden of the private sector in its efforts to revitalize and equip educational

institutions in mathematics and the sciences.

On a separate matter with regard to the R&E credit, we suggest that the Subcommittee clarify for the Internal Revenue Service (IRS) in some appropriate manner that it was congressional intent to have the "independent research and development" (IRAD) of government contractors qualify in full for the credit irrespective of advance agreements limiting overhead allocations and irrespective of types of contracts to which IRAD costs are allocated. The original legislative history of the R&E credit is hopelessly confused on this point, and seems to contradict the statute itself. Moreover, we believe that IRS now is implementing the statute in a way that is inconsistent with its plain wording and contrary to sound policy.

Background

The several bills under examination and their subject matter

are summarized below.

R&E Tax Credit

Pursuant to Code Section 44F, a nonrefundable income tax

credit is allowed for qualified R&E expenditures paid or incurred by a taxpayer in carrying on a trade or business of the taxpayer. The credit applies only to the extent that the taxpayer's qualified R&E for the taxable year exceeds the average amount of the taxpayer's yearly qualified R&E in a specified base period (generally, the preceding three taxable years). The rate of the credit is 25 percent of the incremental

amount.

For purposes of the credit, the statute adopts the definition of "research and experimentation" used for purposes of the special deduction rules under Code Section 174, subject to certain exclusions. R&E eligible for the credit consists of (1) "in-house" expenditures by the taxpayer for research, wages and supplies used in research, plus certain amounts paid for research use of laboratory equipment, computers, or other personal property; (2) 65 percent of amounts paid by the taxpayer for contract research conducted on the taxpayer's behalf; and (3) if the taxpayer is a corporation, 65 percent of the taxpayer's expenditures (including grants or contributions) pursuant to a written research agreement for basic research to be performed by universities or certain scientific research organizations.

The credit is available for the taxable year whether or not the taxpayer has elected under Section 174 to expense or amortize the R&E, and the amount of any Section 174 deduction is not reduced by the

amount of the credit. Expenditures for research conducted outside the United States do not enter into the credit computation. Also, the credit is not available for research in the social sciences or human

ities and is not available for research to the extent funded by any person (or any governmental entity).

"Sunset" and S. 738.--The incremental R&E credit applies to qualified research expenditures paid or incurred after June 30, 1981 and before January 1, 1986. S. 738 would eliminate the termination date and establish the credit as a permanent feature of the Code.

IRAD.--As already noted, the law denies research credits to the extent that R&E is funded by any grant, contract, or otherwise. At some point in the legislative dialogue, there was a hurried consideration of how, if at all, to relate this to unfunded IRAD of government contractors subject to advance agreements limiting this form of indirect cost allocation. The outcome took the form of identical footnotes in Senate Report No. 97-144 and House Report No. 97-201 that are confused on their face and clearly should be disregarded in light of the statute, tax equity, and simple logic. Confronted with the "circular" reasoning of the footnotes, the staff of the Joint Committee on Taxation withdrew from them in its General Explanation of the Economic Recovery Tax Act, and simply expressed the view--neither "for" nor "against" credit qualification for IRAD--that Treasury and IRS should decide by regulation the extent to which such amounts should qualify.