This story is the seventh in ScienceInsider’s After Election 2014 series. Through Election Day on 4 November, we will periodically examine research issues that will face U.S. lawmakers when they return to Washington, D.C., for a lame-duck session and when a new Congress convenes in January. Click here to see all the stories published so far; click here for a list of published and planned stories.
Today, a look at what will happen to the so-called R&D tax credit, which expired at the end of 2013.
The R&D tax credit is designed to create an incentive for businesses to invest in research. And while everybody agrees that it works, figuring out how to pay for it—it has cost the U.S. Treasury about $7 billion annually in recent years—has made it politically impossible to make permanent.
In January, lawmakers allowed it to expire for the sixth time in 21 years. And while there’s little doubt in Washington that, regardless of who wins on Election Day, Congress will eventually move to revive the credit, there’s plenty of uncertainty surrounding what the renewed credit will look like—and whether lawmakers will grant industry’s long-standing wish to make the tax break permanent.
“Those are the questions of the day,” says Christina Crooks, director of tax policy at the National Association of Manufacturers in Washington, D.C., one of many trade groups pushing Congress to renew the credit.
This isn’t the first time that the break—officially known as the research and experimentation credit—has been in flux. Since Congress first enacted it in 1981, it has been extended 15 times and undergone five major rewrites. The last major changes occurred in 2008, and an array of groups, including industry associations and economic experts, say it is time for a major overhaul.
Many are urging Congress to make the credit more generous in order to prevent the United States from falling farther behind nations that offer heftier tax incentives for research. They also want lawmakers to make the credit simpler and easier for smaller companies to claim. Most of all, however, advocates have renewed their long-standing call to make the R&D credit a permanent part of the tax code, rather than a temporary provision that must be renewed every few years. That impermanence has created uncertainty for companies trying to make long-term investment decisions, critics say, and potentially chilled spending on innovation. “The simplest way of making sure U.S. companies remain competitive is to remove the uncertainty by making the credit permanent,” Crooks says.
It’s an idea that has been repeatedly embraced by President Barack Obama and lawmakers from both parties. But there’s a big catch: Making the R&D credit permanent would cost the government $100 billion to $150 billion in tax revenue over the next decade, analysts estimate. That’s a lot of cash to give up as Congress struggles to fund federal programs in an era of austerity. And “if anything, this issue may be even more of an obstacle [to making the credit permanent] in the current Congress,” concludes a recent analysis by the Congressional Research Service (CRS), Congress’s analytical arm.
Still, few quibble with the economic theory behind the credit. Private companies are rarely able to capture all the benefits created by their investment in research, economists have found; some "spill over" into society at large (for instance, in the form of better trained scientists who may move to other firms). As a result, companies tend to spend less on research than is optimal for society at large.
The R&D credit—which is actually a package of four kinds of credits—aims to increase spillover by rewarding companies for spending more on research than they might otherwise. For example, the most recent U.S. version allowed a company to write off up to 20% of what it spends on research above a "base amount" calculated using the firm's spending history. Under one typical scenario, a hypothetical firm that spent $100 million on research in 2013 could cut about $8 million from its tax bill, according to CRS. Studies suggest that every dollar in R&D tax relief can prompt a business to spend at least one additional dollar on research (although some critics have questioned such claims).
The credit has proven popular with U.S. firms. In 2010, they filed nearly 13,000 claims seeking credits totaling $8.5 billion, according to Internal Revenue Service estimates. (Not all claims are ultimately allowed.) Larger companies with revenues of more than $250 million per year typically account for a majority of the claims.
Although the United States is considered a pioneer in the use of the R&D credit, in recent years other nations have also begun to offer generous tax incentives for research. In 2012, U.S. incentives ranked 27th on a list of 42 national policies rated by the Information Technology and Innovation Foundation, a Washington, D.C., think tank. (India, France, Portugal, and Spain topped the list.) That ranking has fallen four places since 2007, when the United States was 23rd.
That dip has helped fuel calls for a major rethink of the U.S. credit. Crooks, for instance, argues that “enhancing the incentive would increase the chance of the U.S. regaining its mantel as a leading innovator.” And groups representing smaller companies and startup firms, seen as hotbeds of innovation, have argued for making some version of the credit more accessible and attractive to those firms, which can lack the hefty research budgets or revenue streams needed to take full advantage of the credit.
Lawmakers in the Senate and House of Representatives are listening. Over the past year, they have introduced more than two dozen mostly bipartisan bills that range from simply reinstating the credit for a few years to massively revamping it and making it permanent. So far, three of these bills have made appreciable legislative progress and are likely to shape the discussion when Congress returns for a 6-week lame duck session after the election.
In the Senate, the body’s Finance Committee this past April approved legislation (S. 2260) that would revive dozens of expired tax breaks, including the R&D credit, for 2014 and 2015. It would also tweak the credit to make it more accessible to small companies and potentially make it more generous for all companies. The full Senate has yet to act on the bill.
In the House, lawmakers have passed two similar bills that would enhance and simplify the credit, but also make it permanent. This past May, 62 Democrats joined 212 Republicans in approving the American Research and Competitiveness Act (H.R. 4438). And in September, the 32 Democrats sided with 221 Republicans in approving the Jobs for America Act (H.R. 4). Neither bill, however, identifies how Congress would replace the estimated $155.5 billion over 10 years in lost tax revenue—the main reason White House officials have said that they would recommend Obama veto the plan if it became law.
Against that backdrop, Congress watchers see several potential postelection scenarios. Perhaps the least politically perilous is for the lame-duck Congress to approve something similar to the Senate proposal, renewing the expired credit for 2014 and 2015 with relatively few changes. A variation might be a short-term extension that makes permanent a few new provisions that won’t break the bank, such as those easing access for startup firms.
Other industry advocates, however, worry that a short-term fix would remove any pressure for lawmakers to push through desired reforms or make the credit permanent. Privately, they say yet another extension would be better than nothing, but not very satisfying. (They declined to speak publicly for fear of appearing greedy or ungrateful.)
Such long-term concerns, however, pale in comparison to an overwhelming agreement among advocates that Congress shouldn’t let the credit lapse for a full year, as it did once in the 1990s. “We’ve gone almost [a year] without the R&D tax incentive … and whatever Congress does with the credit, it needs to make sure it is seamless and leaves no gaps,” Crooks says. At a minimum, she and others say, that mean reinstating it retroactively for 2014.