State Technology Funding Declines
September 29, 2003

By Margot Carmichael Lester

Conservative estimates project that states have already axed between $20 and $40 billion from their operating budgets, with billions more projected by year-end. In California, legislators voted in July to trim $11 billion from the budget and mitigate the $38-million deficit by instituting new fees, if not new taxes.

Across the nation, state cuts include technology spending - on their own IT infrastructures and in financing innovations in the public and private sectors. For this reason, tech industry observers have stopped asking, "How low can they go?" Instead, they're asking new, tough questions:

· Who's going to get the biggest slices of the steadily shrinking new economy pie?
· Will the lack of funds spur innovation or diminish it?
· What will the funding crisis mean for the future of state-supported technology development?

All told, the budget slashing has wide-ranging implications, from unemployment and further declines in economic growth to less scientific research and stifled technology innovation in business and universities.

That's the kind of trickle-down economics that makes technology boosters break out in a cold sweat.

We asked three experts to give us their views on the state of state technology spending and its impact on various sectors of the innovation marketplace. Here's what they told us.

Big Slices, Small Pie

"Funding for all technology sectors -- especially related to the new priorities of homeland security and aerospace and defense -- is up greatly in the federal budget," says Rohit Shukla, Larta's executive director.

That could be good news for California, which has a long-standing reputation as an aerospace and defense leader. But not anymore.

State budget cuts haven't done away with the know-how, but they have done away with new federal funding. How? To address its own budget problems, the federal government now requires states to match its innovation funding. So if Northrop-Grumman wants to win a multi-million dollar federal contract, and it involves several smaller subcontractors, they would have to pony up matching funds. The state has traditionally been a partner in these efforts. But cuts in the state line-item for these funds no longer exist.

Earlier this year, Governor Gray Davis signed an executive order closing the state's source of matching technology funds, CalTIP. The technology-oriented investment program was created in 1994 with $6 million from the Petroleum Violators Escrow account. The program included a grant-making provision to leverage federal grant dollars. Later, the program was moved to the General Fund, making it vulnerable to the boom and bust cycles that mark California's budgetary problem.

"This program was the most viable of its kind in the country because California is a leader in university spin-offs, startups and applied technologies," Shukla explains. Based on early successes, the program's budget was increased to $8 million in 1999. But by 2001, when budget pressures increased, CalTIP was cut back to $3 million. Tech boosters weren't surprised when the ax fell this year.

"California's leadership in these areas is threatened by the lack of matching support for companies unable to derive funding from the open market," Shukla says. Without state and federal funds, development could take far longer, stretching already tight resources to the breaking point.

The cuts affect start-up and established companies.

"The impact on the start-ups looking for federal funding is not just great, it is catastrophic," Shukla notes. "Especially as other companies from other states become more competitive because their states still have similar programs providing matching funds." For some start-ups, the lack of financing could force them out of business altogether.

While the impact on larger companies may not be as severe, cuts in state support are still problematic.

"Many established technology companies took advantage of CalTIP to push risky areas of development, such as products based on research conducted by employees or external partners engaged in innovative research," he says. "Potentially, the elimination of the program robs these companies of vital and innovative technologies which may now have to go nfounded."

"The entire infrastructure of support was stimulated by CalTIP," Shukla notes, "which was a preliminary raison d'être of the technology program in the State."

Innovation, More or Less

"The immediate results have been some layoffs, hiring freezes, reduced or cancelled contracts, and re-evaluation of planned IT projects," says Chris Dixon, digital government issues coordinator for NASCIO, an association representing state chief information officers, information resource executives and managers from the 50 states, six U.S. territories, and the District of Columbia.

"I don't want to make it sound like the states are abandoning projects midstream for no other reason than budget cuts, but they are setting new timelines and priorities for projects not yet underway."

Dixon remains bullish, however, believing the budget cuts will drive development of more cost-effective and efficient state government systems and services.

"NASCIO expects to see more emphasis on positive cost reductions through the use of IT, which creates new efficiencies and improves self-service delivery of government services to citizens," Dixon says. "This should spur better use of government-wide information system standards, business cases, project management, and return-on-investment methods for planning."

No one disputes the fact that lean times often force new solutions. But how much of what is developed by state IT workers will be an innovation rather than simply an improvement? And will any of it ever make it out of state government and into the commercial sector? While states may support technology transfer, they aren't particularly adept at creating truly ground-breaking technologies, much less commercializing any but those developed in public university labs.

Regardless of their viability in the open market, government-developed operational efficiencies will make up only so much of the shortfall, forcing many legislators to look for alternate sources of revenue.

"In tough budget times, governments often shift a greater burden on businesses," explains says Jeff Reid, executive director of the Center for Entrepreneurship at the Kenan Institute for Private Enterprise in Chapel Hill, North Carolina. "That can be devastating to small businesses and entrepreneurs who are already suffering from poor market conditions."

Some states are proposing increased corporate taxation to line their dwindling coffers. Others hope to ease individual economic pain by increasing wages and benefits.

"When a startup company is struggling for market acceptance, new costs such as increased minimum wage, higher payroll taxes, higher health insurance costs, and increases in various government fees make it that much harder to succeed," Reid says.

States also look for more "creative" sources of funds, like targeting overhead receipts -- money used to pay for laboratory space, graduate assistants, utility bills, research equipment, etc. -- from research grants at public universities.

"Top universities attract hundreds of millions of dollars in federal research grants," Reid notes. "Without these critical resources for researchers, technology development would be curtailed. Unfortunately, some state governments are in such dire straits that lawmakers are considering taking that money away from the universities, effectively decreasing the amount of future commercializable technology."

The Impact on the Future

Spending cuts and "creative financing" could spell disaster for technology innovation, especially in states where IT and scientific research and development - in the public and private sectors - is a major source of economic development.

"Fewer federal dollars will flow to the state in areas outside of aerospace and defense -- because those dollars flow to large companies, many of whom have operations in California," Shukla says. "Start-ups with the kind of technologies relevant to an increasingly important national mission and national priorities are likely to have a harder time -- especially because private funding is unable (and unwilling) to take up the slack. That kind of funding tends to favor established products and guaranteed revenue."

By contrast, Dixon sees at least some opportunity for spending growth.

"Eventually, state governments will put more emphasis on back-end efficiencies such as integration, enterprise resource planning, and elimination of duplicative business processes that will make digital government services more useful with fewer manual interruptions," he says.

"This could result in increased IT spending while overall spending is reduced," Dixon continues. "It will take a little while for senior policy makers and elected officials to come around to this viewpoint. State CIOs will need the community of IT innovators in each state to help them make the case to key policymakers."

Read more about The Death of CalTIP from the August 4th, 2003 issue of Larta VOX.

Find out more about government technology grants in Larta's Winning Government R&D Money: 2003 Federal Technology Funding Guide.

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