The President’s FY 2015 Budget Underinvests in U.S. Competitiveness and Innovation

Obama

We are in a world where Republican budgets cut government and taxes—including government spending that is truly investment—and where Democratic budgets increase spending and taxes— including taxes on corporations that compete globally. And so it should be no surprise that the President’s budget mostly conformed to this pattern.

To be sure, there are many things to like in the President’s Fiscal Year 2015 Budget. On the positive side of the ledger is the budget’s call for a slate of programs designed to boost U.S. advanced manufacturing and industrial competitiveness—such as the Administration’s call for $1 billion to create a National Network for Manufacturing Innovation (NNMI) comprised of 45 Institutes of Manufacturing Innovation that are poised to play a key role in revitalizing U.S. manufacturing. The President’s budget also calls for $1.5 billion in funding for the National Nanotechnology Initiative (NNI), $5.1 billion for the Office of Science at the Department of Energy (DOE), and $3.8 billion for the Networking and Information Technology Research and Development (NITRD) program, which plays an important role in keeping the United States at the leading-edge of advanced research into high-performance computing and cybersecurity. It also calls for long-awaited, though relatively modest, funding increases for advanced manufacturing programs such as the Advanced Manufacturing Technology Consortia (AMTech, slated to receive an additional $15 million) and the Manufacturing Extension Partnership (MEP, which has long punched above its weight in generating economic return from every federal dollar invested and is slated to receive an additional $13 million). The budget further allocates $29 million for the National Science Foundation’s (NSF) contribution to the National Robotics Initiative, which will accelerate the development and use of robots in the United States, and $22 million for NSF to contribute to the Materials Genome Initiative. In total, the $135.4 billion allocated for federal R&D activities in the President’s FY 2015 budget will support many programs generating significant return to the U.S. economy, its knowledge base, and its long-term innovation potential.

The proposal also calls for some positive changes to the tax code, including making the R&D tax credit permanent and increasing the rate of the Alternative Simplified Credit (ASC) from 14 percent to 17 percent, a desperately needed change as the United States has fallen to 27th in the world in R&D tax credit generosity. The Administration also proposes a novel allocated tax credit to support investments in communities that have suffered a major job loss event. And as ITIF has recommended, the budget proposes taxing carried interest as ordinary income as a way to pay for some of these expenditures.

But given the significant challenges facing the U.S. economy regarding productivity, innovation and competiveness, the FY 2015 Budget request still falls far short of what is truly needed. For example, then-President-elect Barack Obama promised to double funding for core science agencies including the NSF, the National Institute of Standards and Technology (NIST), and DOE’s Office of Science on a budget by 2018. But, as the chart below shows, the President’s proposed funding for these agencies falls 25 to 30 percent short of the investment levels needed to remain on that doubling path. And while proposed FY 2015 funding for NSF does provide a slight 1 percent increase over enacted FY 2014 levels, NSF funding increases at a rate less than inflation; moreover, the Administration’s FY 2015 request for NSF of $7.3 billion is actually less than its $7.6 billion request in 2014. Further, in the FY 2015 budget, funding for biological sciences, computer sciences, and engineering at NSF (the 3 areas with the largest impact on innovation and growth) actually decreases, with only the social sciences division slated to receive any real increase.

Shortfall from Doubling Goal

Elsewhere, the proposed $30.2 billion in funding for the National Institutes of Health (NIH) in 2015 actually represents a 3.6 percent decline over the FY 2014 request. This would exacerbate a growing divide in critical investments in biomedical research between the United States and our global competitors. As a recent report from The New England Journal of Medicine, Asia’s Ascent—Global Trends in Biomedical R&D Expenditures, found, from 2007 to 2012 countries’ average annual investment in biomedical R&D increased by 33 percent in China, 12 percent in South Korea, and 10 percent in Singapore, while it fell by 2 percent in the United States. In large part that’s because of the complementarity between public and private investment in R&D; the less we’re publicly investing in biomedical research, the less private sector investment and innovation in life sciences we’re going to get. And as ITIF writes in Leadership in Decline: Assessing U.S. International Competitiveness in Biomedical Research, stagnant investment in the life sciences will greatly hinder the United States’ efforts to retain global leadership in biomedical research, especially with China planning to invest twice as much in current dollars (our $150 billion vs. China’s $308 billion) and four times as much as a share of GDP over the next five years.

Even more disconcertingly, the proposed budget puts the United States on a trajectory toward significant overall cuts in growth-inducing investments over the next decade. In fact, by 2024, NSF’s budget is slated to decline by 5 percent in real terms, the Department of Transportation’s by 6 percent, DOE’s by 8 percent, the Department of Education’s by 12 percent, and the Department of Commerce’s by 13 percent. Yet Departments with largely consumption-based budgets, such as Health and Human Services, Agriculture, and Veteran’s Affairs, don’t get hit with any cuts.

This reflects a deeper problem in that according to the budget’s forecast, by 2024 discretionary expenditures—i.e., investments in the core building blocks of innovation such as scientific research, infrastructure, and skills—will fall by 22 percent, while non-discretionary spending—i.e., mandatory expenditures for entitlement programs, debt service, etc.—rises by 30 percent. Far from being an innovation and competitiveness-centered budget, this is actually a consumption budget that will lead to long-term economic stagnation and competitive decline. In fact, the President’s 2015 budget allocates $252 billion for debt service—interest payment on the national debt—46 percent more than the $135.4 billion it allocates for federal investment in R&D.

Moreover, the budget penalizes U.S. corporations that must compete in global markets. Despite a pledge to reduce the corporate tax rate to 28 percent as part of his campaign, the President’s 2015 budget proposes an increase in corporate taxes of 6 percent by 2024, including $276 billion in new taxes on multinational corporations. The budget would also end deferral of foreign-sourced income, a completely inferior proposal to finally making the switch from a worldwide to a territorial tax system. And while the budget does appropriately call for increased investment in transportation through a four-year, $302 billion surface transportation reauthorization proposal, the Administration would fund this more from corporate taxation, not from user fees, which groups like the National Surface Transportation Infrastructure Financing Commission call for. Also, consistent with the Democratic philosophy of small business good, large business bad, small businesses would get a number of tax breaks, including on expensing investment while larger, more productive enterprises would not. Specifically, the budget proposes to permanently extend the 2013 Section 179 expensing and investment limitations for small business, with a deduction limit of $500,000 and a $2 million level for beginning the phase-out (indexed for inflation for all taxable years beginning after 2013). The budget would also make the exclusion for small business stock gains permanent and would encourage and reward new investment in qualified small business stock.

The budget does include some elements recognizing the importance of trade to the U.S. economy, but here too could go much further. It contains a proposed 8 percent increase for the International Trade and Investment Administration (ITIA), including $15 million to accelerate operations of the Interagency Trade Enforcement Center (ITEC) along with an additional $20 million to expand SelectUSA, a program which seeks to raise awareness of the United States as an attractive location for foreign investment. However, funding for the United States Trade Representative’s Office (USTR) is basically flat and there’s nothing in the Department of Justice budget directed to countering innovation mercantilism or intellectual property theft.

In conclusion, the President’s FY 2015 budget does direct funding toward a number of important initiatives in R&D and spurring the commercialization of innovations in the United States, but it does not arrest the long-term trend of continued underinvestment in the core building blocks of U.S. competitiveness and innovation. As it stands today, the United States already invests more than $60 billion less in R&D as a share of GDP than it did in 1983. We need to be significantly increasing investments in R&D, not holding them flat at a rate that barely accounts for inflation. We also need to be cutting taxes on business, especially those competing globally, not raising them.

We are still waiting for a true competiveness budget from either party: a budget that would significantly shrink entitlements and expand investment; a budget that would increase taxes on individuals while cutting it on businesses that invest and compete globally. Sadly, it appears that we are long way away from getting this from either party.

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About the author

Stephen Ezell is a Senior Analyst with the Information Technology and Innovation Foundation (ITIF), with a focus on innovation policy, international information technology competitiveness, trade, and manufacturing and services issues. He is the co-author with Dr. Atkinson of "Innovation Economics: The Race for Global Advantage" (Yale, 2012). Mr. Ezell comes to ITIF from Peer Insight, an innovation research and consulting firm he co-founded in 2003 to study the practice of innovation in service industries. At Peer Insight, Mr. Ezell co-founded the Global Service Innovation Consortium, published multiple research papers on service innovation, and researched national service innovation policies being implemented by governments worldwide.
  • Wayne Caswell

    While I agree that we should invest much more in strategic infrastructure, basic research, education, and skills development, the political question is where that money comes from. As I look at the widening gaps in income, wealth and opportunity, where America now has the widest income disparity of any nation on earth by far, there seems to be only one reasonable answer, and that’s with higher taxes on those who benefitted the most from the economic recovery and not harming those who were most harmed by the great recession.

    The main problem with raising the top tax rate is that it covers too many people, including owners of small businesses, so I support adding at least two NEW tax brackets with tax rates set at something like 50% and 70% for income above $1M and $10M, and possibly 80-90% for income above $100M. But that won’t go far enough without closing loopholes such as treating carried interest as capital gains. Investment income and inheritances should be treated as regular income and taxed accordingly once the amount exceeds $1M or some other threshold.

    What Reagan didn’t seem to understand is that taxes on the wealthy and investments in the strategic infrastructure and the middle class actually benefit the wealthy the most by driving long-term economic growth.