Around this time every year, Congress and the administration begin their annual battle with so-called “tax extenders.” These diverse provisions in the tax law share one thing in common: They expire on a regular basis unless Congress renews them. And, unlike spending programs, Congress has to pay for an extension of existing tax law. The result is an agonizing process of trying to find temporary savings to pay for renewing at least some of the provisions for a year or two. Because Congress was unable to reach agreement last year, the provisions expired at the end of 2014.
Two extenders are especially important to driving innovation and productivity. Economic studies show that both the research and experimentation tax credit (also known as the R&D credit) and bonus depreciation encourage investment and economic growth. In both cases, a clear public policy rationale exists because companies are unable to capture all of the broader economic benefits that their investment creates.
Some form of both should be enacted into permanent law. Until that happens, Congress needs to retroactively extend them through at least 2016. Retroactivity is necessary to assure companies that they will eventually get the full benefit of the tax provisions even if their periodic renewal is delayed for political reasons.
The R&D tax credit was first enacted in 1981. In passing it, Congress hoped to reverse a decline in private spending on research and development as a share of GDP that began in the 1960s. This slowdown was matched by a decline in both productivity growth and U.S. competitiveness in a number of key industries. The provision gives companies a tax credit equal to a portion of their increased spending on R&D. Although the United States was one of the first countries to enact an R&D tax incentive, an ITIF paper documents that by 2012, the U.S. had fallen to 27th out of 42 countries in tax relief for R&D.
Researchers have estimated that the gross social returns from R&D are at least twice the private returns, indicating that the normal level of underinvestment is quite high. In its original proposal for corporate tax reform, the administration argued that the R&D tax credit resulted in $2 of additional research by the private sector for every $1 in lost tax revenue. It estimated that the social benefit of this additional spending ranges between $2 and $2.96. Other studies have found even larger impacts per dollar of tax revenue lost. Another ITIF report estimated that raising the related alternative simplified credit for qualified research expenditures to 20 percent (from its current 14 percent) would increase productivity by 0.64 percent and GDP by $66 billion per year. Moreover, increased federal tax revenues from the greater economic activity would exceed revenue losses within 15 years.
Bonus depreciation, meanwhile, allows a company to write off a large portion of eligible capital equipment in the first year. By lowering the after-tax cost of capital, bonus depreciation should cause companies to invest more. A report by the Congressional Research Service found that economists generally think that a 10 percent decline in the cost of capital should cause investment to rise by 5 percent. Another study found that take-up rates for bonus depreciation between 2002 and 2004 ranged from 54 percent to 61 percent for C corporations and from 65 percent to 70 percent for S corporations. A final study estimated that the provision increased GDP between 0.07 percent and 0.14 percent and created between 100,000 and 200,000 jobs in 2002 and 2003, respectively.