The case for improving America’s research and experimentation tax credit
When it comes to the advanced industries that drive the modern economy — industries like aerospace, biopharmaceuticals, computing, machinery, semiconductors, software, and the internet — America is no longer the undisputed leader. There is an intense race for global innovation advantage on all fronts, as not only China, but also many traditional U.S. allies have made surpassing us a centerpiece of their economic policies. At risk are good-paying jobs, U.S. competitiveness, and national security.
Among the key policy tools that America’s competitors have deployed to establish an edge in that competition are tax incentives for companies to invest in research and development. This is a case of the pupil outdoing the master, for the United States was the first country to establish an R&D tax credit in 1981. As recently as the mid-1990s, the United States maintained the most generous R&D tax incentive in the world. As scholarly studies have shown, that helped America stay ahead of its competitors by boosting R&D investment, innovation, jobs, and GDP growth.
Fast forward to today, and it’s a very different picture. Among the 30 OECD nations with more than 4 million people, plus the BRICs (Brazil, Russia, India and China), America’s R&D tax credit support ranks just 24th in its generosity. This is because other nations have realized the importance of R&D incentives and have either added them to their innovation policy tool box or expanded them. China’s R&D tax subsidy, for example, is 2.7 times more generous than America’s. Overall, the U.S. R&D tax subsidy rate is just 57 percent of the median rate of these other nations.
And it gets worse. Starting in 2022, because of provisions in the Tax Cuts and Job Creation Act of 2017, the United States will be on track to be one of the few countries that does not allow companies to expense current R&D costs. Letting this change go ahead would dramatically reduce the generosity of the credit. In fact, it would drop the United States to 32nd out of 34 nations.
It would be one thing if these other nations were adopting a policy tool that was ineffective. But research and experience shows that R&D tax incentives spur investment and economic growth.
Moreover, while states like California, Michigan and Massachusetts are home to firms that invest disproportionately in R&D, all states have firms that invest significant amounts in R&D. For example, in Idaho, business investment in R&D accounts for almost 3 percent of the economy. And all congressional districts have high-tech firms that employ scientists and engineers—precisely the kinds of firms that invest in R&D. Moreover, firms of all sizes, including start-ups, take the credit. It has become even more common since the passage of the 2015 PATH Act, which allowed eligible start-ups to apply some of their R&D tax credit to their payroll taxes.
All of this being the case, it comes as no surprise that President Biden’s American Jobs Plan would expand the R&D credit. There is also bipartisan, bicameral legislation: The American Innovation and Jobs Act, introduced by Sens. Maggie Hassan (D-N.H.), Todd Young (R-Ind.), Catherine Cortez Masto (D-Nev.), Rob Portman (R-Ohio), and Ben Sasse (R-Neb.), along with the companion American Innovation and R&D Competitiveness Act, introduced in the House by Reps. John Larson (D-Conn.), Ron Estes (R-Kan.), Jimmy Panetta (D-Calif.), Darin LaHood (R-Ill.), Suzan DelBene (D-Wash.), and Jodey Arrington (R-Texas), would make several critical improvements to the credit.
First, it would expand the refundable R&D credit so that more start-ups and young businesses can use the credit, something that is particularly important for young firms with limited cash flow. Second, it would restore incentives for R&D investment by ensuring that companies can continue to fully deduct R&D expenses in the year they are incurred. Members are also working on legislation to at least double the regular R&D credit from 20 percent to 40 percent and the Alternative Simplified Credit from 14 to 28 percent.
Expanding the R&D tax credit has broad support because it would boost innovation in all 50 states while spurring clean energy technologies, creating good jobs, and boosting U.S. competitiveness and national security. The Biden administration and Congress should seize the opportunity to get this done.
Robert D. Atkinson (@RobAtkinsonITIF) is president of the Information Technology and Innovation Foundation (ITIF), the leading think tank for science and technology policy.