In his State of the Union Address, President Biden called for leveling the global research & development (R&D) playing field by increasing federal R&D spending, specifically by asking Congress to pass the bipartisan United States Innovation and Competition Act (USICA). While USICA proposes increasing government investment in R&D, it does not address a recent taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. change that penalizes private investment in R&D. Policymakers should prioritize a boost in private sector R&D investment by permanently canceling R&D amortization this year, ensuring the U.S. can continue leading on R&D.
When policymakers were designing the Tax Cuts and Jobs Act (TCJA)The Tax Cuts and Jobs Act in 2017 overhauled the federal tax code by reforming individual and business taxes. It was pro-growth reform, significantly lowering marginal tax rates and cost of capital. We estimated it reduced federal revenue by .47 trillion over 10 years before accounting for economic growth. of 2017, they looked for revenue raisers within the 10-year budget window. One of the revenue raisers they selected changed how companies can deduct R&D expenses. Before the TCJA, companies could deduct the full cost of R&D investment immediately, but starting in 2022, companies would have to amortize R&D investment, spreading deductions over five years. R&D produced abroad is now deducted over 15 years.
The aim of the change was to reduce the deficit impact of the bill, but it came at the cost of a negative long-run economic impact. Spreading the deductions over time disincentivizes investment because it means companies cannot fully deduct their investments in real terms—inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. and the time value of money erode the value of deductions in future years.
Requiring R&D expenses to be amortized has made the U.S. less competitive. No other developed country forces companies to spread R&D deductions over multiple years—instead, companies usually receive immediate deductions as well as generous subsidies. For example, China allows R&D expenses to be immediately deducted and provides additional “super deductions” to encourage R&D investment. Among countries in the Organisation for Economic Co-Operation and Development (OECD), 20 provide special, preferential deduction rules for R&D costs.
The U.S. should at least ensure the tax code does not penalize domestic R&D, which can be addressed by restoring immediate expensing. We find permanently canceling the amortization of R&D expenses would boost long-run GDP and long-run American incomes (GNP) by about 0.1 percent, or about $27.5 billion each year in 2022 dollars.
The Senate-passed USICA and its companion bill in the House is one place where policymakers may consider canceling R&D amortization. The proposals would boost spending by government agencies for R&D but notably lack tax changes to end the bias against private R&D investment. If expensing for R&D is included in USICA, it should be made permanent to provide certainty to firms making long-term investments and increase long-run economic growth.
|Change in GDP||+0.1%|
|Change in GNP||+0.1%|
|Change in Capital Stock||+0.2%|
|Change in Wage Rate||+0.1%|
|10-Year Conventional Revenue Effect||-$131.3 billion|
|10-Year Dynamic Revenue Effect||-$107.9 billion|
Tax Foundation, Options for Reforming America’s Tax Code 2.0, Tax Foundation, Apr. 19, 2021, https://www.taxfoundation.org/tax-reform-options/?option=9.