I understand that the other body has approved some type of bill that would allow larger companies to merge for purposes of R&D. Senator DECONCINI. That is correct. We have passed the bill on the antitrust R&D that would permit the sharing and some limited disclosure of the patents and the trade information that they have.

It is a carefully worded bill that has Senator Metzenbaum's and Senator Hatch's, two different perspectives, agreement on that bill. Chairman RANGEL. Are the industries targeted or is it across the board like the existing law?

Senator DECONCINI. It is across the board, but it permits the industry to share R&D without being in violation of the antitrust laws.

Chairman RANGEL. Is it possible then for McDonalds and Burger King and all of them to join together to use this to perfect a better hamburger, as I understand some of these credits are being used?

Senator DECONCINI. We did not delve in the hearing process into the use in such businesses. We were primarily dealing with hightech industries, competitive overseas industries, that made a very good case in testimony that they were really cramped and were noncompetitive with foreign high tech industries.

Chairman RANGEL. Your testimony seems to be targeted in that

area.

Would you suggest that, if we want to extend the credit, that we take a look to see whether it should be targeted to certain types of competitive industries rather than fashion designers and fast food operators?

Senator DECONCINI. Yes, sir. I think really this credit here is primarily to be sure that the United States is competitive with some of our high-tech competitive allies and friends who have direct or indirect Government subsidies.

We don't have that except that this tax credit is a subsidy. But legitimate subsidy encourages R&D investment and that is what we need to be competitive. It should not be totally across the board, it should be restricted.

Chairman RANGEL. We will need your views in the future on

this.

Mr. Dorgan.

Mr. DORGAN. Thank you, Mr. Chairman.

Senator, our question with respect to this credit is with what efficiency is this credit being used? If the Government forgoes revenue that it needs or otherwise it ought to have, what is it getting for that forgone revenue?

I think those are legitimate questions to ask with respect to every line on the income tax return, every exemption, every exclusion. We are starting to have to do more and more of that because of the Government deficit.

Research and development is critical for the economic health of this country and for this country's enterprise to stay competitive around the world. I share your interests about that.

I would like to ask you more of a general question. I have been thinking lately about full integration of the corporate income tax which would suggest elimination of the corporate income tax, taxing corporate profits at the stockholders' source.

If that were the case, if you essentially eliminated the corporate income tax, you would obliterate all the tax deductions you are talking about.

What is the Government's responsibilities and function in the R&D of the type you are talking about?

Senator DECONCINI. Mr. Chairman, that is an interesting proposal and one that I would not pretend to be an expert on. I can only give you an off-the-cuff opinion.

I would suggest, thinking about it for the first time, that maybe such an elimination would be strong encouragement, and I don't have a wording for that, that the reason for it is to promote not just greater profits and greater distribution of those profits to stockholders, but to invest in more R&D because that is where the future lies.

I know, in my State, Motorola, Digital, companies like that, that is where their future lies. Digital is a good example. It pays little or no dividends because their profits go into R&D to be competitive, and they are. This credit has been very, very helpful.

A company like that, if it had an integrated corporate income tax, I think would invest. Whether all companies would, I don't know. Maybe that is where the free market should manage itself. But I like this incentive because it says you will be rewarded for taking the chance that you are going to be more competitive.

I am also a strong proponent of eliminating all of these tax credits and deductions. As the chairman said, I would eliminate them for my own constituents, if we really put in some kind of flat tax or some kind of new system. In that case, I wouldn't be here saying, well, don't forget us cotton farmers in the West or hydroelectric powerplants, that we need some incentive. I am willing to go the whole route if we do it for everybody.

Mr. Chairman, I am very young, like you-still idealistic, like you are-and I would like to think sometime the Ways and Means Committee and Finance Committee will truly address that particular problem, maybe not the DeConcini proposal or Bradley proposal, but the Rangel proposal or Dorgan proposal, that would get at the major numbers of all of these deductions or credits.

Mr. DORGAN. I have discovered that there is a constituency for everything, including waste.

Chairman RANGEL. Solid waste.

Mr. DORGAN. There is a constituency for every single provision in the Internal Revenue Code, every one. That is what makes it difficult for us to make the changes that are necessary.

With respect to R&D credits, we want to know with what efficiency those are being used because it is revenue forgone.

As the chairman alluded, are we using R&D credits to perfect a Chicken McNugget, a skinless tomato, a banana that tastes like an orange?

Is the use of these credits really moving us in the direction of being able to compete more effectively in international markets? We have some serious problems ahead of us in American industry in being able to compete in the years ahead.

Aside from these questions, we can hardly compete with some of the toughest competitors around this world in the future while we pay $1,000 per capita per year in this country for defense and our

competitors, the Japanese, West Germans and others, pay, in the Japanese case, $90 per person per year for defense. That is about $900 per person difference in commitment to defense for that umbrella over the free world.

That $900 in Japan goes into the private sector-I assume much of it for R&D. In this country it goes into the public sector in the form of taxes and over to the Defense Department to pay for jet fighter planes, tanks, and carriers.

It seems to me with that kind of imbalance and the capability that gives the West Germans, Japanese, and others for R&D in the private sector to build better toasters, better television sets, better Toyotas, I don't see unless we correct that imbalance, we will be able to compete 20, 30, 40 years from now.

That is a serious problem and it deals specifically, in my judgment, with R&D capability in our country vis-a-vis our competitors. Senator DECONCINI. Mr. Chairman, Mr. Dorgan raises a good point because I don't quarrel with our spending a larger amount than Japan or West Germany.

I do quarrel with the amount that the Reagan administration has thrust upon us. I happen to be a Senator who believes in a strong defense, as I am sure many of you do. What is really the point is that we are carrying the burden for someone else.

Mr. Dorgan, you pointed out so well the inconsistencies of our umbrella for the Japanese who are fine allies and a part of the free world, but they have to bear the responsibility of their nation and the international security that we presently supply to them.

I think you raise a very, very important point.

Mr. DORGAN. Mr. Chairman, we all agree in tax fairness and a strong America.

Senator DECONCINI. Please approve this bill before you do the flat tax.

Chairman RANGEL. Thank you for your well thought out remarks.

Senator DECONCINI. Thank you, Mr. Chairman.

Chairman RANGEL. Our next witness will be from the General Accounting Office, Johnny C. Finch, who is Senior Associate Director of the General Government Division.

Mr. Finch, we recognize the short notice that was given in order for you to present to us your findings on the use and effectiveness of this tax.

We also know that your time was limited in acquiring the type of IRS information that you would need to give us a more full report. In any event, we appreciate what you have done for us. You know that we will not be legislating this year. We hope that you can keep this as a basis, updating it as more data becomes available to you.

As you well know, the record will remain open until September 17. The committee will be still in touch with you for any additional information that you have.

We have your testimony and without objection, it will be entered into the record. We hope that you might highlight and summarize it for us this morning.

STATEMENT OF JOHNNY C. FINCH, SENIOR ASSOCIATE DIRECTOR, GENERAL GOVERNMENT DIVISION, U.S. GENERAL ACCOUNTING OFFICE, ACCOMPANIED BY JOHN GUNNER, GROUP DIRECTOR, AND TOM WOLTERS, SENIOR EVALUATOR

Mr. FINCH. Thank you, Mr. Chairman.

Before I begin, may I introduce the people at the table with me. To my left is John Gunner. John is our group director who manages GAO's work in the tax area.

To my right is Tom Wolters, a senior evaluator who directed the work that was done in response to your specific request, the results of which we will report on this morning.

Mr. Chairman and members of the subcommittee, we are pleased to be here today to assist the subcommittee in its inquiry into the use and effectiveness of the research and experimentation tax credit.

The credit, which was enacted as part of the Economic Recovery Tax Act of 1981, authorizes certain taxpayers to reduce their income tax liabilities by a percentage of the amount spent on qualified research and experimentation. Through this legislative provision, the Congress sought to encourage business firms to perform the research and experimentation necessary to increase the overall competitive stance of the U.S. economy.

The tax credit is scheduled to expire on December 31, 1985.

Today, this subcommittee is holding hearings with a view toward determining whether the credit should be retained beyond 1985 and, if so, whether the credit should be modified to make it more effective.

In preparation for this hearing, the subcommittee asked us to gather certain information on industry and IRS experience with the credit.

Due to time constraints, we did not attempt to develop a complete scientific analysis of the use and effectiveness of the research and experimentation tax credit. We tried instead to quickly identify, and then gather information on, a judgmental sample of companies that were potential users of the tax credit.

In so doing, we recognized that any data we developed would not be projectable to larger populations. Although the information we developed is not statistically projectable, we nonetheless believe that it provides some insight into issues relating to the tax credit which should prove helpful in the congressional decisionmaking process.

We identified our sample of companies through several different sources including:

First, data filed by public corporations with the Securities and Exchange Commission concerning their expenditures on research and development activities.

Second, IRS-provided information pertaining to taxpayers who had claimed the tax credit.

Third, a listing of high technology companies provided to us by a trade association representative.

We found that a wide variety of companies had claimed the tax credit. Of the 109 tax credit users, included in our sample, 172 or 2 percent were involved in manufacturing operations. Their prod

ucts included chemicals, metal implements, machinery, computer hardware, software, electronic equipment, and transportation equipment in part and many others.

The remaining 37 companies included service companies such as banks, credit bureaus and providers of data processing and health services as well as product wholesalers and retailers, public utilities and mining firms.

Besides identifying the users of the tax credit, we tried to make two determinations about the activities for which the credit was claimed.

First, we wanted to find out in broad terms the kind of research and experimentation activities engaged in by various users of the credit.

Second, we wanted to determine, where feasible, the types of research and experimentation activities that were initiated at the margin. We asked various companies to tell us whether the tax credit had enabled them to undertake research that otherwise would not have been undertaken.

We were able to obtain broad information on the research and experimental activities engaged in by 182 of the 289 tax credit users included in the sample. We obtained this information through interviews and/or IRS-supplied tax information.

A total of 139 companies were involved in research activities directed at developing new products and/or improving existing products. New and improved products included medical equipment, machinery, drugs, food products, smoke detectors, oil seals, engines, and brakes.

In contrast, research activities for 44 companies involved the development of new or improved processes. For example, mining and oil companies were seeking to develop new techniques for the extraction of ores, oil, and fuel. Some manufacturing companies were attempting to develop new production techniques for electronic equipment associated with aerospace experimental projects as well as for processing new fuel and oil additives.

The research activities for 43 companies involved computer software applications. These companies included banks, credit bureaus, and utilities, as well as companies for which computer software was a major product line. Software-related activities included the development of new computer programs and the enhancement of computer compatibility.

Besides gathering broad, overall information on the kinds of research being conducted, we also asked company representatives whether the credit had enabled them to carry out any research and experimentation that otherwise would not have been undertaken. We were able to obtain this information from eighty-six of the 92 companies we contacted that had used the tax credit. Of those 86 companies, five told us that the tax credit had encouraged them to initiate new research projects.

One company, for example, applied the credit to the development of new office machines, another to new automobile-related products, and a third to new uses for fiberglass. The value of the credit to these five companies for the period 1981 through 1983 was about $10.6 million.