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Now that the deficit-financed mini-boom is over, economic growth is settling back into what seems to be its new, long-term normal of slightly over 2 percent per year. This is a big problem, because the health of our political and financial systems is closely linked to growing incomes. A future with 3 percent growth is much better than one with only 2 percent growth.
Given demographic trends, the only way to get faster growth is to increase productivity: produce more and better products for less. Unfortunately, productivity growth has fallen significantly in the last two decades. The best way to address this is to increase investment, especially in research and development (R&D). Numerous academic studies show that the R&D tax credit is effective in doing this, producing at least one extra dollar of research and two to three dollars in social value for every dollar of lost revenue.
Unfortunately, the U.S. tax credit has never been particularly generous. The Organization for Economic Cooperation and Development (OECD) calculates the generosity of each country’s credit annually. In 2000, the United States ranked 10th among OECD members. By 2008, its ranking had fallen to 18th, and by 2016 it was 25th. The 2018 rankings show the United States tied for 26th among OECD members and 32nd among all countries included in the report.
The U.S. tax credit subsidized about 5 percent of an extra dollar of qualifying research in profit-making firms, according to the OECD, compared to a median of 13 percent among all countries in the club. That was up from 3 percent in 2017. Unlike other countries, however, the United States requires companies to reduce their tax deductions by an amount equal to the tax credit. By lowering the statutory tax rate, recent congressional tax reform reduced the cost of giving up this deduction.
While other countries have enacted more generous tax incentives for research, the U.S. credit has gotten less generous since 2000. Unfortunately, the generosity will soon fall further, because tax reform also required companies to begin amortizing research over a five-year period starting in 2022. Currently law allows them to expense it.
Support for research investment should take the form of a web of policies including grants for basic and applied research, protection of intellectual property, and tax incentives such as an innovation box. Given the strong academic evidence, the R&D tax credit should be an important component of this web. Congress should increase the alternative simplified research credit (ASC) from 14 percent to at least 20 percent. ITIF has estimated that this would create 162,000 new jobs and eventually pay for itself over 15 years through higher tax revenues. Congress should also pass recent legislative proposals to increase the benefits that newer, pre-revenue companies receive from the credit.