Wednesday, March 25, 2009 - The Progress & Freedom Foundation Blog

Finally, an R&D Tax Credit Done Right

The Obama administration's recent budget calls for a ten-year extension of the tax credit for private-sector research and development expenses.  See the White House press release.  That is welcome news.

The exact details of the credit are, like all other things tax-related, rather complicated, but it costs the Treasury about $7.5 billion per year.  Also complicated is the history of the tax credit:  For the nearly thirty years that the tax credit has existed, it has been often granted annually, and sometimes retroactively.  It has expired some thirteen times in its existence; sometimes Congress steps in to provide retroactive credit, and sometimes there is no credit at all.  A useful timeline of the R&D tax credit appears on page 3 of this report.  Most recently, it was not until October 2008, as part of the emergency economic stimulus, that the tax credit was provided retroactively for fiscal year 2008.

President Obama notes that every dollar of the tax benefit "stimulates as much as an additional dollar of private R&D spending in the short run and two dollars in the long run.  Every $1 of R&D adds $2 of benefit to our economy and society as a whole."  A little online research will show that some detractors cast doubt on those numbers and see the credit as an unreasonable subsidy to large corporations.  An economic analysis of the exact benefits of the R&D tax credit is beyond the scope of this blog entry; it seems safe to assume, however, that the tax credit spurs a substantial amount of R&D.

Using tax policy to spur R&D seems eminently reasonable.  The alternative to private sector R&D is, of course, public sector R&D or directed research grants.  That's a tricky thing for this or any government to do well.  Where public money should be allocated is highly politicized and highly charged.  Public investment in R&D forces the government to make big bets on the direction of technology.  But technology is by its very nature highly unpredictable.  I would rather have a thousand companies themselves bet on the direction of technology than the government by fiat.

The way in which the tax credit has been doled out in past years, however, gives credence to some of the detractors of the R&D tax credit.  A tax credit meant to serve as an incentive for R&D spending should actually provide that incentive.  Retroactive tax breaks arguably fail to provide any incentive.  This concept comes up all the time in connection with intellectual property rights:  Should patent terms or copyright terms be allowed to be extended retroactively?  See, for example, the Supreme Court's 2003 decision in Eldred v. Ashcroft regarding copyright term extension.  Retroactive payouts do not increase incentives to invent; they reward people who have already done so.

Research labs do not spring up overnight, and they do not disappear like Cinderella's carriage at the stroke of midnight New Year's Eve.  Any reasonable reliance on a tax credit for R&D necessarily will span several years.  Accordingly, the tax credit itself should also span several years.  That way, the private-sector can make reasonable and informed decisions.  The Obama budget should be commended for doing just that.

posted by Sidney Rosenzweig @ 2:02 PM | Taxes