Improving the R&D Tax Credit in America

In Federal

The R&D tax credit continues to be a debate in Congress every year. In May, the House passed a bill to make the R&D tax credit permanent which has yet to be approved by the Senate and the White House.

According to experts at the Wharton School of Business and New York University, fundamental questions on the best approach to the tax credit, include: Should incentives encourage some kinds of research over others? Should investments simply be fully expensed when made? And, should the credits be made permanent?

Visiting Professor of business economics and public policy at Wharton and a professor at New York University, Nirupama Rao, is an advocate for the credit and says it proves to have a positive effect on the U.S. economy.

“The overwhelming evidence is that they are effective. If you make R&D cheaper for corporations, they seem to do more [of it]…a 10% decrease in the price of R&D leads to a more than 10% increase in R&D spending,” said Rao, according to Knowledge@Wharton.

While researching the impact of the R&D tax credits, Rao found that the credit saved companies between 6% and 7% of their overall tax liability.

“A 7% discount is not trivial,” said Rao. My research and research by others have shown that that is enough of a discount to get the companies to spend more. We do get some bang for our bucks when we are dishing out these tax credits.”

If Congress goes through with making the credit permanent, they should also get rid of its complexities. Neither of the current methods for calculating the credit encourage R&D, according to Rao.

The traditional credit requires qualifying companies to calculate the ratio of their total R&D spending divided by total sales between 1984 and 1988. Companies that were created after those dates or do not have documentation for those four years are entitled to a flat 3% as their base to calculate the credit. “Having a base that is based on 30 years ago is silly. It’s before the Internet, [and] before pharmaceutical innovation,” said Rao.

The other method known as the alternative simplified credit is the more popular option, which is based on a company’s R&D spending over a three year period. Rao believes this method causes companies to delay their investments “because every dollar you spend today becomes part of your base for the next three years. That undermines the credit. It leaves a lot of firms out in the cold with negative rates or low rates and we are weakening the incentive for R&D,” she said.

Her advice to lawmakers is to offer a flat tax rate of 4% on all R&D spending. “It’s simple, it doesn’t rely on data from 30 years ago and it doesn’t have that moving average base that leads to low and negative credit rates for many firms.”


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