Historically, U.S. companies have been allowed to deduct their research and development (R&D) expenditures immediately. However, the Tax Cut and Jobs Act of 2017 requires companies to capitalize and amortize their R&D expenditures over a five-year period, reducing the financial value of the R&D tax incentive.
While the act was surmised to harm R&D investment, a new scholarly study provides hard evidence of this effect. Mary Cowx et al. studied the impact of the 2017 provision on firms’ R&D investment decisions. Examining a sample of 672 U.S. firms, they found that the requirement increased firms’ cash effective tax rate (ETR) by 11.9 percentage points and the current effective tax rate by 9.9 percentage points. As such, firms’ cash ETR and current ETR increased by 61.7 and 50.5 percent, respectively.
Due to this higher tax rate, many firms reduced their R&D investments. Indeed, the study found that domestic firms (those operating only in the United States) affected by the new requirement reduced their R&D investments by 2.7 percent more than comparable unaffected firms. This translates to a decrease of $13.2 million in R&D investments per firm in the first year. Domestic firms also reduced their R&D investments more than multinational firms affected by the requirement, likely because all their R&D expenditures are subject to the requirement. Moreover, impacted R&D-intensive firms reduced their R&D investments by 3.8 percent more than unaffected R&D-intensive firms, which translates to a decrease of $58.8 million per firm in the first year. Additionally, this group reduced their investments more than low intensity R&D firms.
However, some firms did not reduce their R&D spending in response to the new R&D capitalization requirement. The study found that while affected financially constrained firms reduced their investments by 2.5 to 9.5 percent more than unaffected firms, unconstrained firms did not reduce their R&D spending. These firms’ capital expenditures were 7.4 percent lower than the prior year. As such, overall R&D investments are likely lower than would be expected had the new tax requirement not become law.
It is time for Congress to correct this and pass the Tax Relief for American Families and Workers Act of 2024 to restore the immediate expensing of R&D expenditures.
