NCPA - National Center for Policy Analysis

It Is Time to Make the R&D Tax Credit Permanent

February 28, 2012

The research and development (R&D) tax credit was first enacted in 1981 in an effort to improve the international competitiveness of American businesses by encouraging innovation and new technology.  Concerned about the budgetary impact of lost tax revenue, Congress never made the credit permanent -- though it has renewed it 14 times, say Pamela Villarreal, a senior fellow, and Brian Bodine, a graduate student fellow, with the National Center for Policy Analysis.

In recent years, firms have basically had two tax credit options:  the regular research credit or the alternative simplified credit.

  • The regular research credit is allowed for spending in excess of a specified base amount -- the ratio of research and development to sales expenses in previous years.
  • The alternative simplified credit has been available since 2007 and is a 14 percent credit for expenses in excess of 50 percent of R&D expenditures averaged over the firm's three preceding tax years.                                                                                                             

Fourteen other developed countries, and the three largest developing countries -- China, India and Brazil -- have more generous R&D tax credits than the United States:

  • France tops the list, with a 42.5 cent effective tax credit for every dollar of R&D spending.
  • India ranks fourth, with a credit of 26.9 cents per dollar of R&D.
  • Brazil ranks fifth, with a credit of 25.5 cents per dollar.
  • China ranks eighth, at 13.8 cents per dollar.

Meanwhile, the United States ranks an abysmal seventeenth, with an effective tax credit of 6 cents -- lower than the credit three years ago.

Two policy changes would make the R&D credit competitive with other countries. 

First, increase the credit. 

  • According to Ernst and Young, increasing the simplified credit will increase R&D spending by an additional $5 billion in the short-run, and by $8 billion to $18 billion in the long-run.
  • Increasing the alternative simplified credit, combined with the regular research credit under current law, would increase R&D spending by $23 billion to $53 billion.

Second, the R&D tax credit should not be contingent on a year-to-year renewal.  Even though it has been repeatedly extended, the last-minute decision-making creates uncertainly for firms wishing to plan over several years.

Source: Pamela Villarreal and Brian Bodine, "It Is Time to Make the R&D Tax Credit Permanent," National Center for Policy Analysis, February 28, 2012.

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