This six-chapter report is designed to provide a background against which the U.S. Congress can evaluate specific policy initiatives in the innovation area. Chapter I, an introduction, considers the potential for increased innovation and the government role, focusing on R&D investments and private-sector incentives. Chapter II discusses the links between R&D and innovation and defines the roles played by the different actors in the innovation process. Chapter III presents evidence on the relationship between R&D and economic performance, emphasizing international competitiveness. Chapter IV presents an overview of current trends in R&D funding, considering R&D spending by agency, output-based descriptions of federal R&D spending, and recent trends in private R&D spending. Chapter V discusses government incentives (other than direct funding) for private-sector innovation, concentrating on tax expenditures, which have the most immediate budgetary impact. Chapter VI presents some policy options in the areas of innovation and R&D. This report supplements the detailed analysis of current R&D budget proposals that is provided by the Congressional Budget Office (CBO) special study, "Research and Development Funding in the Proposed Fiscal Year 1985 Budget." In keeping with CBO's mandate to provide objective analysis, no recommendations are offered. (JN)