Twelve Tax Reforms to Spur Innovation and Competitiveness

With many provisions of the Tax Cut and Jobs Act (TJCA) set to expire at the end of 2025, the next Congress will be considering tax reform. To be effective, reform will need to address a wide array of issues. However, reform needs to place a priority on U.S. innovation, especially as China rapidly gains ground as a leading innovator in advanced industries. Toward that end, ITIF offers 12 specific proposals for Congress to enact:

1. Double the R&D tax credit. The R&D tax credit doesn’t just spur more R&D investment in the United States, it also makes R&D-intensive U.S. companies more globally competitive. Congress should double the R&D tax credit rate from 20 to 40 percent for the regular credit, and from 14 to 28 percent for the Alternative Simplified Credit (ASC).

2. Restore full expensing of R&D expenditures. The TCJA eliminated companies’ ability to expense R&D expenditures in the first year for tax purposes. This raises the after-tax costs of their R&D investments.

3. Expand the refundable R&D credit for pre-profit start-ups. In December 2015, Congress passed the PATH Act, which expanded small businesses’ access to the R&D credit by permitting them to claim the credit against their employment taxes or against their alternative minimum credit (AMT) tax. Congress should pass the Research and Development Tax Credit Expansion Act of 2023, which will increase its scope. This bill expands the number of firms that qualify for a refund on their payroll taxes by raising the maximum amount of gross receipts from $5 million to $10 million annually.

4. Broaden and expand the R&D credit for collaborative research. The United States provides a 20 percent credit for collaborative R&D, but the credit only applies to energy research. Congress should eliminate the energy restriction. Research consortia, whether with companies or universities, tend to focus more on basic and exploratory research, which have big spillovers, with many of the benefits going to other firms and society. Therefore, firms do less of this kind of research than is economically optimal. That is why a number of other countries, including Canada, Denmark, Hungary, Japan, France, Norway, Spain, and the United Kingdom have in the last decade established more generous incentives for this form of research.

5. Congress should make companies’ expenditures on global standards-setting eligible for the R&D credit. Business investments to participate in global standard-setting processes are an important component to ensuring U.S. competitiveness. But because of the free-rider problem (where companies that don’t invest the effort benefit from the actions of other companies that do), U.S. companies appear to underinvest in standards-settings activities, just as they do in R&D. Moreover, some nations, particularly China, subsidize their companies’ participation in global standards-setting bodies in order to assure that the agreed upon standards favor their industries. To remedy this, Congress should change the research and experimentation tax credit to allow companies to include their spending on global standard-setting activities when they calculate their total expenditures on research and experimentation.

6. Allow investors in small research companies to use the net operating losses associated with that research. Current law prevents passive investors from taking advantage of net operating losses or research tax credits of the companies in which they invest. This makes sense for tax shelters that are never meant to be profitable. But it makes it even harder for small research companies to find investors. Congress should create an exception for companies that devote more than half of their expenses to research and development, and that have fewer than 250 employees and less than $150 million in assets. Investors should only be able to use that portion of the losses or credit that was devoted to qualifying research activity. Doing so would incentivize investors to fund more small research firms.

7. Allow small research companies to carry forward their net operating losses, even after a change in ownership. Firms can normally carry past net operating losses forward to deduct them from future income, thereby lowering their taxes. Under Section 382 of the tax code, firms lose this ability when they change ownership. An ownership change occurs if the ownership of 5-percent shareholders increases by more than 50 percent over a three-year period. Since small research firms often engage in successive financing rounds before achieving success, this provision makes it hard for them to ever recover their past losses and artificially inflates their historical income for tax purposes. Congress should exempt the portion of net operating losses generated by small firms that conduct qualifying research and development activities.

8. Restore first-year expensing. The 2018 Tax Cuts and Jobs Act created a five-year provision to allow all firms to expense in the first year for tax purposes their expenditures on capital equipment. By lowering the after-tax cost of investing in new machinery, equipment, and software, this provision spurs faster adoption of technologies. However, this provision has expired.

9. Establish a knowledge tax credit by making expenditures on employee training eligible for the R&D tax credit. Training and ongoing education for incumbent workers are critical drivers of productivity growth and rising worker incomes. Indeed, key way workers acquire skills is through on-the-job training provided by employers. Yet, corporate investment on training as a share of GDP declined from more than half a percent in 2000 to one-third of a percent in 2013. So, to spur greater workforce training, Congress should allow employee training expenses to be added to qualified research expenditures under the research and development (R&D) tax credit.

10. Expand benefits for employer-funded tuition assistance. Congress should expand Section 127, which provides tax benefits for employer-provided tuition assistance, especially because the eligible amount ($5,250 per year) has not increased since 1996. Congress should increase Section 127 to at least $10,525 (accounting for the rate of inflation since 1996) and index the amount to the annual rate of inflation going forward.

11. Create manufacturing reinvestment accounts for small and mid-sized enterprises. Congress should establish a 401(k)-like deferred-investment program that would give small and mid-sized manufacturers greater resources to bootstrap themselves by allowing them to make tax-deferred investments through manufacturing reinvestment accounts. The funds would be available for tax-free withdrawal if used for R&D, workforce training, or capital equipment investments. Connecticut has already put in place such a program.

12. Institute a “Super Chips” tax credit. Companion legislation of the CHIPS Act established a 25 percent investment credit for firms investing in semiconductor machinery and equipment. The next administration should call on Congress to create a similar program that would, for five years, allow companies in a set of advanced, export-based industries to take a 25 percent tax credit on all machinery, buildings, and equipment.