Economy & Budget

Congress should extend tax incentives that encourage investment and create jobs

Congress and the Obama administration recently agreed on a two-year budget agreement extending the debt ceiling and setting new caps on discretionary spending. But they left one important piece of business undone. Before it recesses for the end of the year, Congress needs to extend two important incentives for investment and innovation. Retroactively extending the research and development tax credit and bonus depreciation—or, better yet, making them permanent—would be a great start on the broader corporate tax reform that the country needs.

Unlike most tax law, these two provisions are not yet part of the permanent code. They belong to a large group of so-called “tax extenders” that expire unless Congress regularly renews them. Moreover, unlike many spending programs, budget laws require Congress to offset the cost of extending tax provisions. The search for savings has made this an agonizing process, so painful that Congress was unable to reach agreement on last year’s extension. As a result, the R&D tax credit and bonus depreciation both expired at the end of 2014.

{mosads}Congress should not let that happen again, because the R&D tax credit and bonus depreciation deliver broad benefits to the economy. Rather than target a single industry, they reward a wide range of companies for increasing the amount of research they perform or for purchasing new capital equipment. A large body of academic research has found that these kinds of investments benefit society by contributing to higher pay for workers and by producing better products for consumers.

The R&D tax credit offsets a portion of any costs that companies incur when they increase their investments in research and development. The United States was the leader in recognizing the importance of rewarding research when it passed the first R&D tax credit in 1981, but its tax laws have not kept pace with international competition. The Information Technology and Innovation Foundation found that by 2012, the United States had fallen to 27th out of 42 countries surveyed in the generosity of its incentives for R&D.

The Obama administration supports permanently extending and expanding the credit, arguing that every $1 in lost tax revenue results in $2 of extra research spending and as much as $3 in additional social value. Some people have criticized the tax credit for the complexity of its regulations and its use of an outdated baseline for calculating increased research spending. But if Congress expanded an existing simplified version of the credit, it would address concerns about complexity while still providing a strong incentive for companies to increase their total spending on R&D. Moreover, doing so would not cost the Treasury any money. Indeed, the Information Technology and Innovation Foundation has estimated that increasing the Alternative Simplified Credit tax credit from the current 14 percent to 20 percent would increase national productivity by 0.64 percent and growth the economy by $66 billion. So tax revenues from the higher incomes would exceed revenue losses within 15 years.

Bonus depreciation rewards capital investment in new equipment—a key driver of labor productivity and hence wages—by accelerating the deductions a company can take for its expenditures. Faster depreciation does not increase the total amount of deductions a company can take, but it does move them forward in time. This makes the deductions more valuable to the company and decreases the cost of investment.

The Tax Foundation has previously estimated that permanently extending bonus depreciation would increase GDP by more than 1 percent annually, boost the nation’s capital stock by over 3 percent, and increase wages by about 1 percent while creating 212,000 jobs. So most of the economic benefits would go to workers. Higher incomes would also result in an additional $23 billion in tax revenues each year.

The R&D tax credit and bonus depreciation have both been part of corporate tax law for many years. Although Congress has always extended them, sometimes the provisions have lapsed before Congress has been able to act. Whenever this has happened, Congress has almost always made any extension retroactive, reassuring companies that they can continue basing their investments on both provisions. But a better solution would be to make them permanent parts of the tax code. Because they both help boost long-term growth, their effect on the deficit—and even more importantly, the debt-to-GDP level—would be modest, if not non-existent. 

Kennedy is a senior fellow at the Information Technology and Innovation Foundation, a think tank focusing on technological innovation and public policy.


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