Why Expanding the R&D Tax Credit Is Key to Successful Corporate Tax Reform

The United States has not overhauled its tax code since 1986. Since then, increased global competition has led other countries and U.S. states to lower their corporate tax rates while also introducing or expanding incentives to encourage investment and production. As a result, the United States has fallen behind other nations, both in the level of its statutory corporate tax rate and in the incentives it gives to productive investment, including scientific and engineering research. In fact, the United States currently has the highest statutory corporate rate among OECD countries and now ranks just 25th in the generosity of its incentives for research.

That is why tax reform, especially on the corporate side, rightly remains one of the key policies Congress can pass to boost competitiveness and productivity and raise incomes. However, in their effort to find “pay-fors” for a lower corporate rate, some have suggested that Congress reduce or even eliminate the R&D tax credit, a tax incentive for companies to invest more in R&D that has been in force since 1981. This would be a serious mistake, as it would mean less R&D in the United States, fewer good jobs that are enabled by that, and reduced U.S. economic competitiveness, as firms performing R&D are much more likely to compete in global markets. We should follow the model from other nations, many of which have not only reduced statutory corporate tax rates but also expanded, sometimes significantly, their tax incentives for business R&D. In fact, the United States continues to lose ground compared to other nations when it comes to tax incentives for research, falling from 10th among OECD nations in 2000 to 25th today. To remedy this, Congress should lower the corporate rate while expanding the research credit’s Alternative Simplified Credit rate from 14 percent to 20 percent.

The main purpose of tax reform should be to encourage economic growth by lowering the effective tax rate for investment. While ITIF does not believe that corporate tax reform should be revenue neutral, at least on a static scoring basis, one way to pay for at least some of the static revenue loss from lower rates is to eliminate many special tax breaks. But not all special tax provisions are bad. Some actually increase economic welfare by responding to clear market failures. The research and experimentation tax credit (also known as the research and development or R&D tax credit) is perhaps the most important of these. As noted below, economic studies show that it clearly increases the amount of research companies do in the United States and that this in turn increases social welfare. In 2015, Congress took an important step by finally making the credit a permanent part of the tax code. Reducing, or worse, eliminating the credit would be a huge step backward.

This paper briefly describes the current R&D tax credit. It then reviews the scholarly evidence supporting its efficiency in boosting domestic research and economic productivity. Although the United States was the first country to introduce a research tax credit, this report shows that it has continued to fall behind many of its competitors that have enacted more generous research incentives in an attempt to expand and draw more innovation to their economies. The paper concludes with a firm call for Congress to include a significant increase in the credit’s generosity as part of any tax reform. Toward that end, Congress should increase the simplified version of the credit to 20 percent from its current value of 14 percent.