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2010 Budget Tax Proposal

Make research and experimentation tax credit permanent

Since its enactment as a temporary provision in 1981, the research and experimentation (R&E) tax credit has been extended, with modifications, thirteen times. The president would make the R&E tax credit permanent.

The R&E credit is an incremental credit. Businesses may claim a nonrefundable credit equal to 20 percent of qualified expenditures in excess of a base amount. The base is generally determined by multiplying a company’s average annual gross receipts in the previous four years by its ratio of research expenses to gross receipts during the 1984 to 1988 period. (Companies that did not exist during the base period must use a fixed ratio of 3 percent.) The base cannot be less than 50 percent of qualified research expenses for the taxable year. Firms may elect to use an alternative simplified method that sets the credit at 12 percent (14 percent for 2009) of the increase of current year qualified research expenses over 50 percent of the average of the same expenses for the previous three years. If the business does not have qualified expenses in any one of the three preceding years, then the alternative credit is determined by taking 6 percent of the current year’s qualified expenses.

The rationale for the credit is that investment in research and development often generates social returns (general knowledge or other social benefits) that exceed the private returns to investment. Without government intervention, firms would invest less in research than is socially desirable, making the economy less productive. Supporters argue that the credit provides an important stimulus to research spending. A 2008 Congressional Research Service report (cited below) found that the credit delivered only a modest stimulus to domestic business research and development between 1997 and 2005. Making the credit permanent might increase its effectiveness, however, because  firms may currently forgo lengthy research projects for fear that Congress might allow the credit to lapse although, given past history, that fear could be overstated. Making the credit permanent, however, would give a more realistic picture of future costs; given the repeated extension of the credit, the sunset provision leads to an understatement of its true cost. Critics of the credit acknowledge the social benefits of research, but point out that not all qualifying research and development generates social benefits in excess of private returns. The credit may also induce some firms to choose projects that qualify for the credit over those that generate higher returns.

Additional Resources
Research and Experimentation Tax Credit: Current Status and Selected Issues for Congress, Gary Guenther, Congressional Research Service, Report RL31181, October 2008
Description of Revenue Provisions Contained in the President’s Fiscal Year 2010 Budget Proposal; Part Two: Business Tax Provisions (JCS-3-09), Joint Committee on Taxation, September 2009, pp 7-24