Research Tax Credit: Current Status, Legislative Proposals in the 109th Congress, and Policy Issues
Publication Date: September 2006
Publisher(s): Library of Congress. Congressional Research Service
Technological innovation makes crucial contributions to long-term economic growth, and research and development (R&D) is the lifeblood of innovation. In economies dominated by free markets, a large share of R&D investment is undertaken by private firms seeking to become more competitive and improve their prospects for future growth. Because firms generally cannot capture all the returns to their R&D investments, they are inclined to spend less on R&D than its overall economic benefits would warrant. The federal government supports R&D in a variety of ways, including a tax credit for increases in R&D spending.
This report examines the status of the credit, summarizes its legislative history, discusses key policy issues it raises, and describes legislation in the 109th Congress to modify or extend the credit. It will be updated as legislative activity warrants.
The research and experimentation (R&E) tax credit has never been a permanent provision of the federal tax code. Since its enactment in 1981, the credit has been extended 11 times and modified five times. In reality, the R&E tax credit has four components: a regular credit, an alternative incremental credit (AIRC), a basic research credit, and an energy research credit. All but the energy research credit are incremental in that the credit applies only to qualified research spending above a base amount. The credit expired at the end of 2005.
In effect, the research tax credit seeks to stimulate increased business R&D investment by reducing the after-tax cost to firms of undertaking qualified research beyond a base amount, which appears designed to approximate what a firm would spend on R&D if there were no credit. Although most analysts and lawmakers view research tax credits as a desirable policy instrument in theory, the current design of the federal credit has made it a target of continuing criticism. A major concern is that the design keeps the credit from being as effective as it might. Critics attribute this problem to what they claim are five flaws in its design: (1) its lack of permanence, (2) its weak and disparate incentive effects, (3) its non-refundable status, (4) its inadequate and unsettled definition of qualified research, and (5) its lack of focus on R&D projects that generate much larger social returns than private returns.
Numerous bills to extend the credit and enhance its incentive effect have been introduced in the 109th Congress. Some examples are H.R. 1736, H.R. 4845, H.R. 5115, S. 14, S. 627, S. 2109, and S. 2357. Each would extend the credit permanently, raise the three rates for the AIRC to 3%, 4%, and 5%, and establish what is known as an "alternative simplified credit." For many firms, such a credit would be equal to 12% of spending on qualified research above 50% of their average qualified research spending in the three previous tax years. A bill passed by the House on July 29, 2006 (H.R. 5970) would extend the credit through the end of 2007, increase the three rates for the AIRC, and establish the same alternative simplified credit. It is unclear whether the Senate will vote on the measure before the end of the current Congress.