Make the Research and 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, 14 times. It is currently scheduled to expire on December 31, 2011. The president would make the R&E tax credit permanent and increase the rate of a simplified alternative credit option from 14 percent to 17 percent. Making the credit permanent would reduce federal receipts by $106.2 billion between fiscal years 2012 and 2021.
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 14 percent 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 president would increase the rate of the alternative credit from 14 to 17 percent.
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, however, 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 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 would give a more realistic picture of its future budgetary costs; given the repeated extension of the credit, the sunset provision leads to an understatement of cost over the 10-year budget window. Critics of the credit acknowledge that some research generates social benefits not captured by the firms that perform it, but point out that not all qualifying research and development generates such excess benefits. The credit may also induce some firms to choose projects that qualify for the credit over those that generate higher returns.
Congressional Research Service, Research and Experimentation Tax Credit: Current Status and Selected Issues for Congress (CRS Report RL31181, updated October 6, 2008).
Government Accountability Office, The Research Tax Credit’s Design and Administration Can Be Improved (GAO-10-136) November 6, 2009.