A generation ago, seven citizens handpicked by President Lyndon B. Johnson created a nongovernment policy group to assess the needs of U.S. cities and the effectiveness of government social experiments to help the poor.

The era of the Great Society is long since over, and the Urban Institute, as the organization was called, has emerged as one of the nation's leading think tanks on public policy issues, celebrating this month, in the Reagan era, its 20th birthday.

Initially funded almost entirely by federal grants and contracts, the Urban Institute survived a drastic cut in government support early in the Reagan administration. With the aid of nongovernment grants and contracts, it now has a budget of about $12 million, with about 100 researchers and 50 others on salary.

During the Reagan years, the institute published a massive, rather critical, 26-volume study of the administration called "Changing Domestic Priorities." One conclusion was that President Reagan's policies had helped create an unnecessarily severe recession as part of the price of choking off inflation and had helped create a staggering federal deficit. The study also found that Reagan had revived American confidence that a president can govern forcefully.

The institute also has developed a series of studies to help guide the next president, called "Challenge to Leadership," urging an active government role to combat poverty, counter the growth of a social "underclass" and confront multiple economic problems, and warning against trade protectionism.

The institute has assembled a staff of first-class researchers -- such as economists Isabel V. Sawhill, John L. Palmer and Joseph J. Minarik -- and a recent prized recruit, Rudolph G. Penner, former director of the Congressional Budget Office, among the better-known names.

Perhaps most important, it has survived early suspicions that it would become a super-liberal advocacy group -- derived in part from the fact that it was set up with the aid of the Johnson administration.

"We were created by Johnson, basically, to bring together facts and do research on urban issues in one place, objectively," said institute President William Gorham, an assistant secretary of health, education and welfare and deputy assistant secretary of defense in the Johnson administration.

"We tend to work on the problems of people, and therefore you have to focus on people with problems, and 30 percent of our work as a result is on poor people, blacks, the handicapped and the homeless. To that extent we're 'liberal.'

"But in how we do it, we don't have an institutional view that the poor should get more. We try to be objective," Gorham said.

The institute generally gets good marks in Washington's think-tank community. Stuart Butler, director of domestic policy studies for the conservative Heritage Foundation, said that while "there are clear differences in our overall philosophies," the Urban Institute's research is based on solid technical and professional foundations.

"They do very good work," said Christopher C. DeMuth, president of the conservative American Enterprise Institute (AEI).

The AEI, Urban Institute, the Brookings Institution and the Heritage Foundation are viewed by many as making up the big four think tanks here. Brookings has an annual budget of about $15 million; Heritage, about $14 million; Urban, about $12 million, and AEI about $8.5 million.

While many public policy specialists perceive the Urban Institute as being somewhat on the liberal side of the roster, it carries a wide variety of researchers and their views differ quite a bit. Penner, for example, is generally considered a middle-of-the-road to conservative economist, not a liberal.

"Taking us as the conservative bench mark," said Heritage's Butler, if organizations were rated from very liberal to very conservative on a scale of zero to 100, "we'd rate 100. I'd put the AEI at 70, and the Urban Institute and Brookings at 40 to 50. They're not raging liberal think tanks."

Said DeMuth about the Urban Institute, "They are much more sanguine about the efficacy of government intervention in the economy than I would be."

The institute's liberal label may have been responsible for its greatest crisis: a tremendous falloff in government contracts and grants after Reagan took office.

Its expenditures from all sources totaled $4.5 million in 1970 and rose steadily to a high of $14.4 million in 1980, and most of that was government money. In 1980, $12 million of that total was work for federal agencies. In 1982, with the Reagan administration in office, federal money dropped to $3 million.

As a result, the institute's budget dropped sharply -- to $9.8 million in 1983 -- and appeared likely to plummet.

Whether this funding drop was part of a deliberate policy of the new administration to "defund the left," as the phrase went a few years ago, has never been clearly established.

Gorham said he believes it may have been a factor, but said "a great deal of the defunding that took place in 1982 was really a decision not to focus on certain problems" that the institute had traditionally followed -- such as poverty and related issues.

In any event, groups like the MacArthur, Ford, Carnegie and Mellon foundations stepped in and helped fill the gap, and the institute's sponsors now include dozens of foundations and corporations, such as Aetna Life and Casualty, Manufacturers Hanover Trust Co., Exxon and General Dynamics. The institute's current board chairman is Carla A. Hills, secretary of housing and urban development in the Ford administration. Its vice chairman is Katharine Graham, chairman of The Washington Post Co.

With the financing crisis of the early 1980s over -- the institute has built its level of federal grants and contracts up to about $6.7 million -- officials are looking forward.

"We will certainly continue our policy role in confronting the federal budget deficits," said Gorham, "how to look at it, how to deal with it. The Medicare issue -- how to ease the burden on the elderly and deal with the tremendous pressure of the costs of the system."

He said the institute has a major new project funded by the Ford Foundation "to evaluate the Immigration Reform Act and its impact on American society and that of other countries."

Sawhill will be expanding her work on the "underclass," Penner has major projects under way on reform of the federal budget process, and other scholars are undertaking studies on residential mobility and housing and long-term health care.

"I'm tremendously upbeat," Gorham said, "about the role we're going to play."

THE INSTITUTE ON POVERTY

An Excerpt from "Challenge to Leadership"

"The persistence of poverty in the United States has raised questions about the ability of government to solve the problem and has even led to complaints that government is the cause of the problem. Arguments that welfare and other programs that aid the poor cause cause the breakup of families, undermine the work ethic and create a syndrome of dependency have become commonplace in recent years. Although such arguments are not necessarily consistent with the evidence, they have shifted the terms of the debate and put liberal scholars and activists on the defensive. As President Reagan puts it, in the War on Poverty, poverty won. The persistence of poverty over 20 years would seem to support this view. Unless this history can be reevaluated in a more favorable light and the lessons it suggests incorporated into current thinking, it will be difficult to proceed with confidence that any new government effort to reduce poverty will work."