Expand and make permanent the research and development tax credit

Limiting pro-growth investments in the name of fiscal austerity is a mistake. America can't afford to lose its place in the race for global innovation.

Corporate research and development could increasingly head overseas, where other countries' tax incentives are more generous. Image credit: iStockphoto by Getty

Corporate tax policy has become a lightning rod of American politics. Increasingly, some populist Democrats see it as an issue by which to bash “Benedict Arnold” corporations who move jobs and profits offshore. Meanwhile, libertarian Republicans view tax policy as a way to get government out of the business of “picking winners” through targeted tax incentives, instead preferring a corporate tax code with one low rate for all firms and activities.

U.S. corporate research and development has grown 2.7 times faster overseas than domestically because other countries’ R&D tax incentives are far more generous.
All the while, our global competitors are working assiduously to attract, grow, and scale the innovative enterprises of the future, using corporate tax policy – such as very generous research and development (“R&D”) tax incentives – as a key instrument. Indeed, one reason U.S. corporate R&D has grown 2.7 times faster overseas than domestically is because the U.S. research and development tax credit (“R&D credit”) –once the most generous in the world – now ranks just 27th, with nations like India, France, and Brazil offering significantly better incentives.

It is this context that makes the House’s recent passage of the American Research and Competitiveness Act of 2014 (H.R. 4438) so important. Despite criticism from the left and the right, the bill passed on a vote of 274-131, with about a third of Democrats voting with Republicans to approve the measure.

The bill would simplify the existing credit and increase the amount of the tax credit that companies can claim for “qualified” research expenses from 14 to 20 percent (which would move us to 15th globally in R&D incentives). It would also make the credit permanent, eliminating the need to extend the program each year. These are both ideas that ITIF has long championed.

The American Research and Competitiveness Act would move the United States from 27th to 15th in providing incentives for R&D.
Scholarly research has shown not only that the credit is an effective tool for spurring additional R&D (with one dollar of credit spurring at least $1.20 of R&D) but that it also responds to a significant market failure. As the Congressional Joint Committee on Taxation wrote, “although an individual business may find it profitable to undertake some research, it may not find it profitable to invest in research as much as it otherwise might because it is difficult to capture the full benefits from the research and prevent such benefits from being used by competitors.”

However, despite the rare show of bipartisanship and the strong evidence in support of the credit’s benefits, the bill’s fate is far from certain. The Senate still has to take it up, and it is inclined to extend the credit, not make it permanent. But the strongest opposition to the bill comes from the Obama administration itself. The White House was quick to issue a Statement of Administration Policy saying that the President’s top advisors would urge him to veto the bill. This is despite the fact that the President has consistently trumpeted the need to expand and make permanent the credit.

The reason for the opposition is that the House bill fails to find the requisite budget offsets. But the insistence on a budget offset is, in this case, misguided. The cost of the R&D tax credit should be considered an investment, not spending. By spurring more R&D, HR 4438 would boost economic growth to the tune of $66 billion more a year and help create 162,000 jobs. Moreover, it’s worth noting that the Administration’s insistence on a budget offset in this instance is inconsistent with some of its prior policy—the last budget submitted by the President to Congress would have increased the deficit by $2.4 trillion over the next 10 years.

Expanding the R&D tax credit would boost economic activity by as much as $66 billion a year.
Despite fiscal hawks’ single-minded focus on the debt, it’s a mistake to limit pro-growth investments in the name of fiscal austerity. Debt reduction is a means, not an end. The end is robust economic growth. If there is to be a focus on the debt it should be on reducing the debt-to-GDP ratio. By spurring more R&D, the legislation would boost GDP.  Moreover, if Congress allowed dynamic scoring (e.g., scoring spending and tax provisions on the basis of the secondary effects on economic growth) and based its budget estimates on a window longer than 5 years, this would be a no-brainer. The tax revenues from increased growth would exceed the costs of the credit after 15 years.

Rather than simply saying no, the White House should take the following steps. First, it should call on the Treasury Department to issue an estimate of what it believes the bill would cost on a longer-term, dynamic basis, and second, it should propose the specific offsets it would like to see. This at least would move the debate forward constructively. The United States can no longer afford to stand by while other nations seek to win in the race for global innovation advantage.

Robert D. Atkinson is President of the Information Technology & Innovation Foundation (ITIF), a think tank based in Washington, D.C. Follow: @robatkinsonitif