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An R&D Tax Credit That Works

Congress has, once again, at the last minute extended the research and development tax credit for a single year, making it retroactive to Dec 31, 2009 (when Congress allowed it to lapse) and extending it until the end of 2011.

This cycle has repeated for years. Congress allows the credit to lapse until another short extension is given, preceded of course by a series of fundraisers and speeches about the importance of nurturing innovation. Congress essentially uses this cycle to raise money for re-election, promising industry more predictability the next time around.

In theory, the purpose of tax credits is to encourage additional activity in a particular area, above and beyond what would have occurred without the tax credit.

The R&D tax credit merry-go-round functions to save companies money on their taxes, of course (and to keep lobbyists employed), but does it actually incentivize additional R&D? Because R&D is by its very nature a long-term rather than a short-term matter, if the purpose of an R&D tax credit is to incentivize additional economic activity, its focus must extend predictably into the future, rather than retroactively into the past.

A permanent R&D credit would benefit the economy by encouraging additional R&D, while a continuously lapsing credit accomplishes little.

A permanent R&D credit would allow for tax planning, meaning that corporate executives can have a clear notion of their taxes due as allocated toward any activity. Hiring and investment decisions can be made with the assurance that the new investments and jobs created can be sustained.

A long term (5 years or more) credit would provide some stability and tax certainty. Hiring and investment can be made with a longer term horizon before tax uncertainty creeps into business decisions.

A short term (less than 5 years) extension does not encourage long-term planning and therefore simply reinforces research that is already underway, while allowing some hope that another short term extension is possible so current R&D might not be discontinued.

A continually lapsing credit is least effective of all since it simply provides a tax break to existing R&D efforts. No new marginal R&D is encouraged, hence no new investments, no new jobs.

Many tax reformers advocate against such tax credits, arguing that the real solution is to rewrite the tax code so that our oppressive levels of corporate taxation are lowered for all rather than Congress carving out special areas of favored treatment. And they’re right.

But until that day comes, a permanent R&D credit is probably the best way to encourage the high levels of R&D upon which our economy is so obviously dependent.