The R&D credit is on the list of “extenders” that Congress should take up in the lame duck session before they adjourn in December. Earlier this year, Michael Rashkin wrote in EE Times that “The R&D credit doesn’t work” and advocated for its elimination. Let’s hope Congress ignores Rashkin’s advice. Here’s why.
First, Rashkin’s claim that the credit is ineffective is wrong. He writes the “credit has been in existence for over 30 years. During that time, not one company has announced an invention for a product that was produced as a result of the R&D credit.”
Of course they haven’t because the credit is not intended for specific lines of research. It’s not as if IBM gets the credit to fully support its research on quantum computing, but gets no credit for its advanced battery research. The credit is covers the full range of a company’s R&D. This differs from research support from federal agencies like DARPA and NSF, which Rashkin cites, that support specific research projects. Judging the credit on this basis makes no sense.
Second, Rashkin dismisses the body of scholarly, peer-reviewed academic work on the credit, claiming it is based on invalid “what-if-calculations.” In fact, these reviews use sophisticated econometric analysis and have consistently shown that the R&D credit leads companies to do more R&D than they would otherwise.
Rashkin then goes on to say that these studies show that for every dollar of tax expenditure through the credit only one dollar of R&D is generated. In fact, most studies show a much higher effect, with the range being between $1.30 and $2.90 of corporate R&D induced for every dollar of R&D credit tax expenditure.
Rashkin’s claim that companies will conduct R&D even without the credit, which he acknowledges is wrong when he says the studies show a dollar-for-dollar effect, is beside the point. Without incentives, these companies will not conduct enough R&D, thereby making America worse off.
The single most important reason most economists support the R&D credit is to correct for a market failure called “spillovers.” It’s one thing if Apple, Intel, GE and others received all the benefits from their R&D. But they don’t. On average, U.S. companies get less than half of the total benefits from their R&D and the remaining “spillover” benefits society.
For example, Tewksbury, Crandall, and Crane examined the rate of return from 20 prominent innovations and found a median private rate of return of 27 percent, but a median social rate of return of a whopping 99 percent, almost four times higher. So even if companies invest “rationally” in R&D to maximize profits, they will still be under-investing from a societal perspective. The R&D credit is a key way to address this structural market failure.
Rashkin dismisses this by claiming that “spillovers” do not square with “free market” economics, whatever that is. I would challenge Rashkin to find any legitimate microeconomics textbook that does not discuss the notion of market failures and positive externalities (including spillovers). Only the most hardcore, doctrinaire free-market ideologues believe that markets always get it right and there are no market failures.
Rashkin also seems to think that doing R&D in the U.S. harms the U.S. economy when he claims “to give these companies a research credit in addition is to reward, in many cases, behavior that is detrimental to the U.S. economy.” But the R&D credit does not reward moving production or R&D offshore. It applies only to R&D performed in the U.S., an activity that without doubt is beneficial to the domestic economy.
In response to Brian and George, one can only keep up the good fight and present policy makers with the superior argument. For Bert just because there is an argument to keep a tax incentive does not mean its incorrect or special pleading, just as it would be wrong to say that about spending programs. some are worth continuing and some are not. Its up the policy process to try to figure out which ones are worth it, as is the case with R&D credit. and re BErt's other comment, you are confusing taxes with policies. I think we should cut corp tax rate, but that is not central to the argument for R&D credit, which is that it is a policy that maximizes economic growth more than would be the case if companies just invested on their own accord. Yes, markets do get it wrong. As do companies who are trying to maximize short term equity rather than maximize net present value shareholder value.
You are confusing nominal statuatory rates with actual ones. Our net corporate tax rates are in the low twenties, which puts us right in the middle of the international pack. This, of course, is not a great way to go about things and could use some reform, but it is simply not the case that a typical corporation pays anywhere near 40% in taxes.
And yes, targeted tax breaks are subsidies - sometimes justified and sometimes not. Are we better off with simply lower rates, or slighly higher rates plus the R&D credit? The answer is not obvious as there are merits and de-merits to both sides. But it is hard to work through this when one political party just screams "gub'mint bad cut taxes!!!" and refuses to engage in serious discussion.
I had to read this twice, to see the logic involved.
So, if the government taxes the US operations of corporations to the tune of just about 40 percent, and then it allows the company to retain some more of its profit if it would just spend it on R&D, we need to thank the government for having the foresight to funnel more money into R&D? Because otherwise, the company would never do it on its own?
That seems a bit of a stretch. My way of presenting this would instead be, US corporations, for US operations, are taxed at stratospheric levels. However, AT LEAST the government is smart enough to know to give them a break to incentivize R&D.
And even so, there are some out there who want to take even that break away, with the idea that really and truly, the government knows best how to spend everyone's money, and the profits of their businesses too.
R&D tax credit is indeed a very useful way to incentivize the right kind of activity, but it is much abused by many practitioners. Companies often claim the R&D credit for activities which are not R&D related. In fact, some of these are so ridiculous that it is difficult to classify them as science or enginering of any kind. This is most frequenly done by shifting some SG&A expenses into R&D. It is called creative accounting.
Yes the R&D credit should continue, but its common abuse should be stoppped somehow.
The free market is like gambling in that the combination of skill and luck is frequently rewarded.
But like in gambling, the free market can be and is victimized by people, companies and indeed nations that cheat by introducing market distortions that their fellow honest players can only counter by either electing not to play or by cheating themselves.
Well-written article. Yes, the "free market" will under-supply R&D due to positive spill-over externalities. The R&D credit is likely one of the best ways of correcting this very clear and simple market failures. It really is sad how many libertopian-types refuse to admit that "free market" theory is based on a bunch of ridiculous assumptions that are not even remotely valid in the real world, and that the government can and should correct these deviations when practical.
Yes, I too thought that the original Rashkin article was strinkingly short-sighted and shallow. Even the point about "for each tax dollar saved, only 1 dollar is spent in R&D" doesn't make a lot of sense.
Even if only one dollar extra is spent in R&D, the multiplier is expected DOWNSTREAM, from the products, jobs, etc., that the R&D investment creates. Success of the tax break should not be measured by how much more R&D spending the company does, over and above the tax break. The question is simply, does the tax break create more R&D programs? If the answer is yes, and even Rashkin says the answer is yes, then that's enough.
We are facing crippling national debt because of reckless new spending that both the previous administration and this one have created. I know there are those who keep harping on "unpaid wars." That's part of it, but a much greater spike in public spending was caused by the failed government-backed subprime mortgages. Which burst the housing bubble. A housing bubble created by foolish government programs.
That's what the original TARP program addressed, and that over-trillion-dollar deficit spending became the "new normal" since 2009.
Now the fashion has been to look at taxing more and more, and becoming as creative as possible to "explain" why any previous tax break should be on the chopping block.
A great argument, Robert, but I fear one that faces an uphill battle. In other words I'm less optimistic than George that it will be extended. The tech industry just doesn't seem to have the same lobbying clout as an Idaho potato farmer.
The lame duck session of Congress appears to be consumed with negotiating and the usual posturing over budget "sequestration," aka, "The Fiscal Cliff". The guess here is that perhaps in the course of tinkering with the tax code, lawmakers decide to extend the R&D tax credit for a couple of years to address market "uncertainty" issues.
David Patterson, known for his pioneering research that led to RAID, clusters and more, is part of a team at UC Berkeley that recently made its RISC-V processor architecture an open source hardware offering. We talk with Patterson and one of his colleagues behind the effort about the opportunities they see, what new kinds of designs they hope to enable and what it means for today’s commercial processor giants such as Intel, ARM and Imagination Technologies.