NCPA - National Center for Policy Analysis

Can a Research and Development Tax Credit be Properly Designed for Economic Efficiency?

July 20, 2015

Economic growth is driven by new ideas, innovation, and technology. Since 1981, the research and development (R&D) tax credit has attempted to lower the cost of these activities through subsidies in the tax code. Theory often predicts benefits from subsidies for R&D, but policymakers are not able to properly design and implement such a tax credit. Losses owing to rent-seeking and policy uncertainty undermine the predicted benefits of a well-structured incentive program.

Specifically, Jason Fichtner and Adam Michel of the Mercatus Center find:

  • The largest tenth of a percent of all firms (0.13 percent) claims 82 percent of all research tax credit dollars; the smallest 95 percent of firms claim less than 5 percent of credit dollars.
  • Since 1990 there has been an 83 percent ($7.7 billion) increase in R&D credit expenditures.
  • In many cases when the IRS challenges a claim, taxpayers immediately settle for as little as 50 cents on the dollar, further suggesting aggressive credit claims.
  • Fungible definitions for qualified research allow easier relabeling, resulting in an even larger distortion of the data and the resulting estimates of induced spending.
  • Research suggests that R&D spending can only explain a small portion of patent variance across industries and across time.

 So, can an R&D tax credit be properly designed for economic efficiency? The answer seems to be no, given the imperfect political process and the lack of relevant market knowledge.

Source: Jason J. Fichtner and Adam N. Michel, "Can a Research and Development Tax Credit be Properly Designed for Economic Efficiency?" Mercatus Center, July 2015.


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