Why The Tax Reform Act of 2014 Should Expand, Not Cut, The R&D Tax Credit

Although it contains many positive proposals, the Tax Reform Act of 2014 would reduce the effectiveness of R&D tax incentives.

R&D is a key driver of U.S. productivity growth, innovation and competitiveness. However, relative to societally optimal rates companies underinvest in R&D, which is why since 1954 companies have been able to deduct R&D costs immediately rather than depreciating them, and why since 1981 companies have been able to take a tax credit for R&D expenditures. Unfortunately, the Tax Reform Act of 2014 proposed by House Ways and Means Chairman David Camp (R-MI) would not only significantly reduce tax incentives to invest in R&D but would disqualify R&D expenditures toward software development from the credit.

These changes, if enacted, would reduce the tax incentives for performing R&D in the U.S. by approximately $20 billion per year, raising the effective tax rate of R&D-performing companies. It would also reduce R&D performed in the United States by at least $25 billion annually, which would in turn reduce productivity growth by an estimated 0.18 percent per year going forward. Finally, eliminating the credit for R&D on software, an activity that many industries not just software engage in, would change the allocation of R&D across types of research, negatively impacting innovation. 

The United States cannot afford to be indifferent to where R&D is performed. Given the fact that 26 nations already provide more generous tax treatment of research, these changes will lead to relatively less global R&D being performed domestically, with the negative effects on the economy and jobs to follow. To be sure, America needs sensible reforms that lower corporate tax rates, but these steps should be taken while maintaining, or even expanding, proven incentives to invest such as the R&D tax credit.