Fact of the Week: Key Industries Are the Most Affected by the Elimination of Full Expensing of R&D Activity

Source: Alex Muresianu, “Return to R&D Expensing Crucial for Manufacturing and Technology Investment,” (Tax Foundation, December 2022).

Commentary: Starting last year, businesses are no longer allowed to fully deduct their research and development (R&D) expenditures from their federally taxable income in the first year. Instead, they must amortize the expenses over a five-year period (15 years for R&D performed abroad). This increases businesses’ year-to-year tax liabilities and decreases the real value of their deductions (thanks to the time value of money and inflation). The policy change thus lowers firms’ incentives to conduct R&D. Economists agree that because most of the benefits of R&D and its technological breakthroughs accrue to entities other than the investing firm (e.g., customers, competitors, etc.), the current level of R&D investment is well below what would be socially optimal. This policy change exacerbates this problem, and because of R&D’s position as the driver of technological progress and therefore long-term economic growth, it will hinder the United States’ economic prospects.

In an article published last month, Tax Foundation policy analyst Alex Muresianu discussed the implications of the change for specific industries. Three key industries—Manufacturing, Information, and Professional, Scientific, and Technical (PST) Services—are by far the most adversely affected, as they account for over 90 percent of U.S. private sector R&D. Because of the policy change, 2023 tax liabilities are expected to be $31.7 billion higher for the Manufacturing industry, $3.7 billion higher for Information, and $2 billion higher for PST Services. In contrast, a return to full first-year expensing would reduce PST Services’ tax liability by 29.4 percent, Manufacturing’s by 25.4 percent, and Information’s by 23.1 percent.

That this policy change disproportionately affects these three industries is concerning for several reasons. First, each of these industries has a high employment multiplier—behind only Utilities and Real Estate and Rental Leasing—with each new job in these industries indirectly spurring the creation of 4.2 to 7.4 additional jobs. Second, Information and PST Services are the two industries—measured at the NAICS two-digit level—with the highest average wage ($49 and $48 per hour, respectively). And third, these industries are much more export-oriented than other industries and are therefore more subject to competition in the international market. In 2018, gross exports were 41 percent of Manufacturing output in the United States, 11 percent of Information output, and 9 percent of PST Services output; they were just 7 percent of output for all other industries combined. Thus, by disproportionately and negatively affecting these three industries, the removal of first-year expensing for R&D will result in fewer jobs, a smaller share of high-paying jobs, and a less competitive U.S. economy than would otherwise be the case.