WASHINGTON – As the debate over how to revive U.S. manufacturing heats up, tax and other proposals are emerging to provide incentives for technology companies to boost investment in innovative research that could foster new engines of economic growth.
One of the most intriguing proposals comes from a tax expert who has worked for computer and chip makers, including Apple and Marvell Semiconductor. Michael Rashkin, author of “The Practical Guide to Research and Development Tax Incentives,” says a key tax incentive for tech companies, the R&D tax credit, is too complex, has not increased R&D spending and needs to be overhauled.
Rashkin argues that the R&D tax credit in its current form isn’t working. Created in 1981, the provision gives U.S. companies a tax break on R&D expenses. Other R&D incentives include faster write-offs of equipment and favorable tax treatment for stock option costs.
Those provisions don’t address what’s ailing U.S. innovation and manufacturing, Rashkin says. “American companies used to develop and make their products in the U.S., but we are now witnessing a debilitating outsourcing cycle where taxpayer subsidized R&D is used to create overseas jobs,” Rashkin told the Senate Finance Committee during a September 2011 hearing on reforming the R&D tax credit.
According to Rashkin, the current tax structure works like this: government agencies like the National Science Foundation fund basic research; then tax incentives and other subsidies are used to encourage product development, often based on federally-funded basic research. Rather than investing in U.S. manufacturing of new products, Rashkin told Congress that the current structure encourages U.S. companies to “park the resulting intellectual property in tax havens.”
The result is that U.S. companies attracted by foreign incentives and low U.S. taxation end up outsourcing manufacturing jobs. This means fewer U.S. jobs and little tax revenue, two of the primary justifications for the R&D tax credit.
Rashkin says reform of the “dysfunctional” R&D tax credit should begin by raising the credit to 30 percent from the current rate that he says is only a few percentage points of the total cost of R&D. Another proposed reform is making the credit applicable only to “innovative research and breakthrough products,” Rashkin adds.
In a recent journal article, Rashkin provided the following example of how a revised tax credit should work: “…under this proposal, research on Apple’s first iPad would have easily qualified, but any succeeding models would not unless the improvements were very innovative in nature. Since the development of breakthrough products is usually costly and risky but at the same time provides the greatest benefit to the economy, the credit rate should be increased….”
Other incentives for product innovation and manufacturing investment should include lower tax rates for companies that develop and manufacture products in the U.S., Rashkin told Congress. “By providing this incentive to manufacturers and their suppliers, and by removing the [IP] tax haven advantage, we would reverse the foreign outsourcing trend and reinvigorate the U.S. manufacturing industry,” Rashkin testified.
The R&D tax credit has been renewed several times since its inception in 1981. The technology industry has longed lobbied for a permanent extension. Sen. Max Baucus (D-Mt.), chairman of the Senate Finance Committee, along with ranking committee Republican, Sen. Orrin Hatch of Utah, have jointly proposed a permanent extension of the credit. The proposal also would increase the nominal tax credit from the current 14 percent of research expenses to 20 percent.
“Making this tax credit permanent will provide certainty, and it will help spur economic growth for generations to come,” Baucus said last fall.
Observers doubt whether any tax proposal could make it through the GOP-controlled House of Representatives in a presidential election year. “A bill that does not include making the Bush tax cuts permanent or a thousand other tax provisions” has no chance of approval in the House, one observer said.
As for the Obama administration, one manufacturing advocate notes that “it's not an uphill fight to get the [White House] economists to agree that the country needs to have manufacturing.”
Why is it even needed if R&D is so great for economy. Company would naturally do it anyway. Company don't do R&D because they are looking at next quarter's profit. R&D is a black hole. Stock holder demand next quarter profit so they can sell out again. Stocks are held by the minutes to days selling in and out. There are no long term investment in stock. They are dumped soon as there is a small dip or if stock holder expect a small dip. If you have to hold on to a stock for 5 years, the mentality would be totally different. Stock holder would demand quality R&D. Not just R&D like Apple use to spend millions on for show before Steve Jobs came and got nothing out of it.
Matthew Smith from http://speedyloansearch.com/
I commend the following, just posted to the EE Times opinion section, by tax expert and electronics industry veteran Michael Rashkin:
I have no inside information but I'd say the odds are 3:1 against. What I see in its favor are (1) bipartisan support from the business community for the credit and (2) the fact that it has now expired, which might give a renewal some sense of urgency. You probably know all the reasons behind the more likely outcome of inertia.
OK, Greg, I see the advantage of going for a five-year extension. You and others agree that the R&D tax credit in its current form isn't working as intended. Do you see any chance for any of these tax credit proposals advancing this year? I caught hell from another commenter when I quoted a source as saying it ain't gonna happen in an election year.
A permanent credit is the long term goal, but the credit is badly in need of a redesign. It would be a mistake to make a newly-redesigned credit permanent without forcing a reality check a few years down the road. Five years is long enough for data to become available. Five years is also much longer than the average 2 year extensions the credit has been getting for the past 30 years, which should make it less of a lobbying target (until it nears renewal).
But that's in a perfect world. If business sees a chance to implement something like the current Administration proposal of making the Alternative Simplified Credit permanent at a higher rate, they should go for it.
Thanks for posting the report link, Greg. You favor a 5-year extension. There is an argument that such incremental extensions have only served to generate campaign contributions for members of the congressional finance committees:
Why not make it permanent in exchange for strict requirements for reinvesting revenues in R&D, design and manufacturing here in the U.S.?
Don't think anyone is arguing that reforming the R&D tax credit will solve our manufacturing problem, but the credit certainly is not working the way it was intended: providing incentives to innovate, design and manufacture new products. DrWhoto's analysis of the costs of producing his product designs in North America is an interesting data point in this debate. Your conclusion about developing new manufacturing capabilities and coming up with the investment to do it illustrates the overall problem we face in reviving manufacturing. The Foxconn model won't work here (thankfully), but flexible manufacturing that can be scaled up and down will.
I'll be reporting on one such effort in the Midwest in the next day or so. Stay tuned.
For those interested in delving deeper into this topic, the Center For American Progress recently released a detailed report about the R&D Tax Credit that I co-wrote with Laura Tyson: http://www.americanprogress.org/issues/2012/01/corporate_r_and_d.html
Tax havens and offshore manufacturing are related, but equally complex, topics, and we did not address them in the report.
The main points I'd like to bring out here:
- The complexity of the credit has greatly reduced its usefulness because the IRS takes back a lot of what companies claim. We proposed eliminating both the incremental nature of the credit and its restriction to a set of "qualified research expenditures". Companies already treat the credit as a lump sum, and these changes would eliminate much of the administrative cost for companies as well as the IRS.
- It would be a mistake to change the credit and make it permanent at the same time. A revised credit should get a 5-year extension to give it time to be evaluated.
- The relationship between R&D and manufacturing is more complex than might first appear. R&D is attracted more by the growth of offshore markets and the availability of engineering talent than by the presence of other value chain activities. The R&D credit is one piece of the puzzle of keeping the US R&D environment attractive.
- The R&D Tax Credit is not the answer to all the nation's problems, but study after study has shown that it induces at least as much R&D as it costs the taxpayer. Studies also show that R&D brings benefits to the economy that far outweigh the cost of the R&D. The R&D credit is worth preserving even if Congress gets down to meaningful corporate tax reform.
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