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.”