New Administration Budget has Smart Proposals for Boosting R&D

The U.S. corporate tax system hasn’t had a major overhaul since the early 1980s, and it’s getting long in the tooth. One part that is particularly dated is the research and experimentation (R&E) tax credit provision. The new 2016 administration budget makes some important changes to the R&E credit. The credit was first implemented as a two-year trial run over 30 years ago in 1981, and has been renewed continually since then, eventually adding an updated “alternative simplified credit” (ASC) as the old credit became too unwieldy in many instances. Despite proven success as shown in many academic studies, however, the credit is continually forced to be renewed. The new administration proposal takes the obvious step of making the credit permanent, eliminates the outdated “traditional” credit making a stronger ASC the sole form of the credit, and incentivizes R&D in universities startups by increasing the amount of the credit that companies can claim for outside R&D expenditure.

While the R&E credit has evolved over the past three decades, both its core structure and its temporary span have stayed the same. It is clearly out of date: the law still sets “baseline” levels of R&E expenditure at 1984-88 levels. Alternatively, corporations can use the ASC, but the ASC is generally lower as it only covers 14 percent of qualified expenditures as opposed to 20 percent in the traditional credit.

The new permanent credit would raise the ASC to 18 percent. This is lower than the traditional credit’s 20 percent, but the ASC is applied to 50 percent of the base amount of research spending and above, whereas the traditional credit is only applied to 100 percent of the base and above. The new proposal also increases the credit in several significant ways that ITIF has proposed in the past, including allowing the credit to apply to businesses subject to the Alternative Minimum Tax instead of only businesses using the standard deduction system; allowing a higher percentage of expenditures on outside research to qualify for the credit (from 65 percent to 75 percent).  It would also get rid of a reduced rate specific to businesses that have not done any qualified research in recent years. Raising the percentage of expenditures deductible for outside research expenses should encourage university-business partnerships, a critical source of innovation and new ideas. The AMT provision and the elimination of additional provisions for business owners of pass-through entities also make it easier for newer, small companies to claim the credit. This is because many startups are sole proprietorships that are taxed on the individual level and thus fall under the AMT.

These proposals are common-sense reforms that deserve strong bipartisan support. Research and development is a critical engine of economic growth, and there is solid theoretical and empirical support showing that the credit spurs research that would not otherwise occur—for less than the cost of the government doing it itself. Moreover, the international market for R&D (and the accompanying jobs and industries) grows more competitive daily, as many other countries have adopted similar or even more generous provisions to our 1981 tax code. Polishing up the R&E credit is the best way to ensure that R&E will remain a powerful driver of the U.S. economy.

(thanks to Robert Scoble for the banner picture)