Presidential candidates are long on innovation ideas, but could be short on funding

Both candidates’ agendas support science, technology and innovation. Their approach to funding differs radically. Democrat Barack Obama  plans to double the current $28 billion level of federal funding for basic research. Republican John McCain plans to use tax incentives to encourage private sector investment for R&D. Experts say ongoing economic woes and the inevitability of having to pay for the U.S. bailout plans could hog-tie both funding approaches, and possibly scientific progress as well.

“Clearly at some point we’re going to have to pay the bills of the investments in bailouts and the stimulus packages,” said Ashley Stevens, executive director of the Office of Technology Transfer at Boston University. “As always one’s fear is there will be a crimping on research and development spending.”

The candidates struggled during the third and final presidential debate to come up with areas where they would cut current funding to make way for their proposals and to trim the $455 billion deficit for this year.

Stevens pointed out that under the Bush administration, funding for the National Institutes of Health doubled, but once it doubled, it remained virtually flat. “It would be nice if there were a longer-term plan providing for steady growth,” Stevens said.

He added that in the face of a recession and a hit to corporate profits, the private sector can’t be relied upon to pony up enough cash to fund science.

“Government funding is much more predictable and controllable,” Stevens said.

Hefty price tags

The impact on the federal budget of the science, technology and innovation proposals by Obama would be about $85.6 billion annually and by McCain, $78.8 billion not including his proposal to cut corporate taxes, according to information prepared for the New York Times by the Information Technology & Innovation Foundation, a nonprofit Washington-based technology policy think tank.

The ITIF estimated that about 90 percent of the impact of McCain’s policies would be from tax spending by extending R&D tax credits and allowing corporate tax deductions for equipment and technology expenses in the first year instead of depreciating it over a number of years. Some 83 percent of the impact of Obama’s policies would be from $71 billion in new government spending for science, technology and innovation programs. That’s about the inverse proportion of McCain’s $8 billion of new federal spending on those programs.

The candidates have not given specifics on how they expect to get their proposals funded.

Small blip on the radar

Some experts are dismayed that the innovation agendas are getting little visibility in the current U.S. political dialogue and from the candidates themselves. One of the problems may be outdated economic thinking.

“Innovation policy has gotten short shrift in the U.S. political dialogue largely because the three dominant economic policy models advocated by most economic advisors – and implicitly held by most Washington policymakers – ignore the role innovation and technology play in achieving economic growth in the global, knowledge-based economy of the 21st century,” economist Robert Atkinson, president of the ITIF, said in a recent report on economic policies. “Unfortunately, while the U.S. economy has been transformed by the forces of technology, globalization, and entrepreneurship, the doctrines guiding economic policymakers have not kept pace and continue to be informed by 20th century conceptualizations, models, and theories.”

If the United States is to regain robust growth and maintain its international economic competitiveness, “…it’s time for bold policy action to spur innovation,” Atkinson said in another report containing recommendations to the coming administration for patent reform, tax credits and other innovation policies.

The sentiment is reflected by American citizens as a whole. A recent Kauffman Foundation survey found that Americans see entrepreneurship as the answer to the current financial crisis, though they are personally reluctant to start their own companies because they believe it is more difficult to become an entrepreneur in the current economic environment.

“Americans in big numbers are looking to entrepreneurs to rally the economy,” Carl Schramm, president of the Kauffman Foundation, said in a statement. “More than 70 percent of voters say the health of the economy depends on the success of entrepreneurs, and a full 80 percent want to see the government use its resources to actively encourage entrepreneurship in America.”

Americans also are looking to business leaders instead of government—by a two-to-one margin—to lead the way out of the economic crisis. Some 56 percent trust small business owners to guide the economy compared to only 14 percent who trust members of Congress.

Innovation agendas

McCain’s agenda (see Comparing the Candidates) places emphasis for funding innovation on the marketplace. He supports innovation through public/private partnerships that share costs. He wants to make the R&D tax credit permanent and extend it beyond its current level. He also wants to maintain capital gains taxes at the current 15 percent level. McCain’s plan targets some specific areas, such as devoting $2 billion annually to research fostering the use of clean coal and a $300 million prize to the developer of an advanced battery technology. Regarding patent reform, he wants to provide alternative approaches to litigation for resolving patent challenges.

Obama’s agenda (see Comparing the Candidates) places emphasis for funding innovation on the government. He also wants to make the R&D tax credit permanent, but at the current level. He wants to increase capital gains taxes to between 20 percent and 28 percent, but eliminate capital gains on start-ups and small businesses.

Obama’s plan also targets some specific areas, such as $250 million annually for a national network of public-private business incubators, $150 billion over 10 years for clean energy programs and $50 billion over five years for health information technology. He also could create a Clean Technologies Deployment Venture Capital Fund with $10 billion annually for five years to move promising technologies out of the lab. Regarding patent reforms, he wants to offer patent applicants the option of a public peer review to produce patents less vulnerable to legal challenges.

Start-ups and spin-outs

The impact of the agendas on start-up funding could be mixed. While McCain wants to keep capital gains taxes at the current 15 percent, Obama aims to raise them to 20 percent to 28 percent. However, Obama has a small-business rescue plan that would eliminate all capital gains taxes on investments made in small and start-up businesses. He also wants to end the carried interest provision that allows venture capitalists to recognize investment profit as capital gains. That would mean venture capitalists would pay taxes at the ordinary income rate, effectively doubling the taxes they would pay.

Details on the plans are sketchy. It’s too early to tell how the agendas on eliminating capital gains for startups and changing the taxation on carried interest will take shape, and more will be known after the winning candidate takes office, said Emily Mendell, Vice President of Strategic Affairs for the National Venture Capital Association in Washington, DC.

“Eliminating capital gains taxes for investments in small business could be very favorable and could motivate angel investors, venture capitalists and others,” she said. “We still have a way to go before we see how that would shake out. We don’t know if it would be for a seed investment, first round or follow-on round, and whether it takes effect upon the exit of the investment.”

Taxation of carried interest—the profit private equity managers make on their investments—has been hotly debated in the United States and Europe. The Netherlands, for example, has been mulling a 52 percent carried interest tax. In the United States, the debate lost steam on Capitol Hill last December, but Obama’s agenda may once again ignite the issue.

“This … could have far reaching, negative implications for the start-up community, venture capital investment, and the U.S. economy,” Mark Heeson, president of the National Venture Capital Association, said last year when House of Representatives Democrats proposed a bill to change carried interest taxation.

“Venture capitalists are not in the business of charity,” said James Kim, senior partner in CMEA Ventures in San Francisco. “We need to make money for the limited partners. We need to exit investments after a certain period of time.”

The numbers of those exits have been anemic this year. There were only six venture-backed IPOs in the first three quarters of 2008, the lowest volume for that period since 1977. There was only one IPO in the third quarter, and none in the second quarter (see Tech transfer feels the chill in IPO drought, ScienceBusiness). There were 58 merger and acquisition exits in the third quarter.

“The crisis in the financial markets has further exacerbated an already troubling situation in that most venture-backed companies are postponing or abandoning an IPO exit for theforeseeable future," stated Heesen. “Additionally, the lower M&A transaction volume can be attributed to the expected uneasiness of large corporations who are exercising more caution in their acquisition strategies of venture-backed companies until market conditions become more auspicious.”

Heeson added, “These companies that are ready to exit are very strong, with positive earnings as well as innovative technologies and business models, so they will remain in the venture capital portfolio until conditions improve,” he said. “Should the current situation be prolonged into 2009, we can expect fewer new investments by the venture industry as they will need to spend their time with these later stage companies that are waiting to go public or be acquired.”

CMEA’s Kim added that it is hard, for example, for energy venture companies to find financing to build plants to scale up production. “The checks are too big for venture capitalists, and private equity investors don’t want to take the risk, especially in this market,” he said. “Hedge funds traditional would invest the $100 million for this, but hedge funds now have to worry about writing down debt.”

Kim added that there still is a lot of money available for early stage ventures in energy and other key fields, because those companies have a longer term exit. He said he and other venture capitalists are looking for the IPO window to open again at the end of 2009 and pick up activity in 2010.

Silver lining

Despite the lack of details from the candidates; plans and the low profile the science and technology innovation agenda has had during the campaigns, there are hopeful signs. Both candidates are interested in reducing carbon emissions—Obama wants an 80 percent reduction below 1990 levels by 2050 and McCain a 60 percent reduction by 2050—and both are looking into oil alternatives, with Obama supporting incentives for solar and wind energy and McCain for nuclear power. Both want strong IP protection.

“Both candidates would be better for the United States than the current administration,” said Boston University’s Stevens.

“Clearly innovation and investment in innovative sectors like IT, medical devices and biotech are an important part of the recovery,” said NCVA’s Mendell. “We’re pretty certain both candidates understand that.”