The research and development (R&D) tax credit is one of approximately 50 “tax extenders” periodically employed by the U.S. Congress for temporary periods of time at its discretion. The tax incurs an annual cost in excess of $9 billion, which serves as the fourth-largest corporate tax expenditure in the United States. The tax credit endeavors to stimulate the economy through providing private companies with incentives to allocate capital in technological innovation and investment.
Though the intent of the legislation seeks a positive outcome, some analysts and experts question the efficacy of the measure in the long-run. The Mercatus Center at George Mason University, for instance, published a survey on research development investments and their relationship to tax incentives. Some of the challenges this type of legislation faces in practical application are ambiguities surrounding policy, legal matters and definitions of what constitutes R&D. In fact, the study found that the tax credit often features stealth costs that erode its desired outcomes, and thus argued that the credit should be eradicated with a subsequent cut in corporate taxes across the board.
Analysis of the Study
Below are some key findings related to the study:
- A) The credit lacks empirical data to prove its efficacy. Research in the field illustrates that that tax incentives aimed at stimulating R&D precipitate insignificant investment in private research. In other words, each dollar stemming from the incentive fail to illuminate augmented innovation and, in fact, may erode the caliber of research produced.
- B) Under the law, “R&D” lacks a clear definition. This lack of precision impedes the development of the R&D sought. The lack of clarity also raises confusion with other parts of the tax code that corporations and affiliated parties must spend time and capital discriminating.
- C) The credit creates more costs for companies to manage. Firms spend a great deal of money for lobbying and attorneys to best interpret and execute their efforts within the law. In effect, these costs erode the desired effects of the credit and thus undermine macro economic expansion.
- D) Tax policies of a temporary nature precipitate uncertainty, which businesses respond to with lack of action. Many organizations, especially large ones, prefer to wait to see what the structural conditions of the economic climate will be before allocating resources and making investments.
- E) The benefits of the credit favor large businesses, as it is employed predominately by the largest corporations or top 1 percent of American firms.
Recommendations for Policy
Based on the analysis of the policy and its efficacy, the group argues that ideally the R&D tax credit should be eliminated completely, while the corporate tax rate should be subsequently lowered with the savings created from the change in policy. This proposal would benefit the whole economy, because lower corporate tax rates have been shown to encourage research and development.
If the desired outcome described above is not feasible, then the following alterations to the current R&D should be made to improve its efficacy in terms of reducing ancillary costs and producing enhanced economic expansion:
- A) The credit should be made permanent, thereby providing tax certainty and greater transparency for business leaders to make more impactful investments rather than having to try and predict when the tax incentive will be implemented or repealed.
- B) From a tax code perspective, credit claims on amended returns should be eliminated. The meaning of research from the Internal Revenue Code section 174 should be the standard for defining of what is considered eligible research and development initiatives. In addition, making the alternative simplified credit (ASC) the only option for firms reduces compliance and administrative costs that erode efficiency.