The Research and Experimentation Tax Credit
Background Paper No. 5
As part of the Economic Recovery Tax Act (ERTA) of 1981, Congress enacted a temporary 25 percent tax credit designed to spur research spending by business. The credit was available to businesses with research spending in excess of a base period amount. As an incremental credit, it was designed to encourage additional research spending while minimizing revenue loss to the federal Treasury.
Concerns about the “competitiveness” of U .S. businesses and studies showing low research spending by U .S. business have prompted Congress to renew the research credit repeatedly since 1981. The credit was extended and lowered to 20 percent in the Tax Reform Act of 1986 (TRA’86), extended in 1988 and 1989, modified and extended in 1990, and extended in 1991. The credit expired temporarily on June 30, 1992.
President Clinton had proposed to reenact the research credit on a permanent basis in his FY’94 budget. Congress instead enacted yet another temporary extension to the credit as part of the recently passed budget bill. The credit is extended, with no major changes, retroactive to July 1, 1992, and will expire on June 30, 1995, unless it is extended.
However, Congress may act to modify the credit and establish it on a permanent basis. Senator John Danforth, (R-Mo.), the original author of the credit, has been joined by Senator Max Baucus (D-Mont.) in introducing S. 666 in the current Congress. S. 666 makes the credit permanent and further refines the credit to make it more effective.
The research tax credit provides an additional incentive for research spending beyond the incentive provided by the research deduction. Research expenditures may be viewed as capital spending since they provide future benefits and would normally generate future amortized deductions. However, since 1954 businesses under section 174 have been able to expense all qualified research spending in the current year, thus providing a tax benefit.
The research tax credit has encouraged some additional private research investment since being implemented in 1981. However, the credit’s incentive effects have been substantially diminished by its structure and because businesses have been hesitant to invest in additional research when the tax benefit of doing so has been temporary and transient.
This paper provides an overview of the purpose, legislative history, and effectiveness of the research tax credit and summarizes recent proposals to reauthorize the credit.