# Presentation: 528253

## The R&E Tax Credit: Rationale, Structure, and Performance

**Paul N. Doremus**
**National Institute of Standards and Technology**
- Strategic Planning & Economic Analysis Group
**http://www.nist.gov/director/planning/strategicplanning.htm**
- Ref.:**  *****The Effectiveness of Research and Experimentation Tax Credits***
**http://www.wws.princeton.edu/~ota/ns20/alpha_f.html**

- 17 July 1998

## Economic Rationale for R&D Policy: Broad Economic and Societal Gains

**Industry R&D generates economic growth**
**Industry R&D can be a public good**
**R&D spillovers**
**Economic spillovers**
**Firms recoup some but not all of the benefits from their R&D investments**

## Economic Rationale for R&D Policy:Market Incentives Alone are Insufficient

**General undersupply of R&D**
**Undersupply of R&D in specific areas**
**Inherently governmental missions and/or interests**
**Fundamental or basic research**
**Breakthrough, infrastructural, and multi-use technologies**

## Economic Rationale for a Tax Credit: The General Undersupply of R&D

**Purpose: get more R&D at the margin by augmenting R&D investment incentives for all firms**
**Strategy: use tax credits to reduce the cost of capital for R&D**** **
**Credit offsets a portion of R&D costs**
**Lower costs raise the net present value of prospective research projects; more likely to meet corporate hurdle rate**

## Credit Structure: Incremental, not Fixed

**IRC Section 41:  “Credit for *****increasing***** research activities”**
**Mechanism:  20% tax credit for the portion of qualifiable R&D that exceeds base amount**
**Key factor:  The *****base period***
**Base amount:  Product of fixed base percentage and average annual receipts over last 4 years**
**Fixed base percentage:  Average R&D intensity (qualifiable R&D over sales) during 1984-1988.**

## Credit Structure: Other Major Provisions

**Alternative Incremental Credit (1996)**
**Purpose:  make credit available to R&D-performing firms that cannot effectively use main credit**
**Structure:  three credit levels--1.65, 2.2, & 2.75%.  Rate based on extent to which qualifiable R&D exceeds a percentage of average gross sales over prior four years--by 1.0-1.5, 1.5-2.0, or 2.0+%, respectively**
**“****Basic research credit” (41(e))**

## Credit Performance: Does It Work?  

**Econometric studies: Credit stimulated $1+ in R&D for every $1 in revenue cost**
**Applicability varies.  Most effective for:**
**Firms with rapidly increasing R&D expenditures**
**Firms with current R&D intensities that are higher than the 1984-1988 period.  Some factors:**
**Change in level of sales relative to R&D**
**Change in structure of the firm**
**Corporate tax status**

## Credit Performance: Who Uses It?

**Large manufacturing firms (>$250m) claim approximately 70% of the credit**
**Relative magnitude:  credit revenue cost equivalent to approximately 1.5% of corporate R&D funds**
**Composition of corporate R&D (1997e):  **
**6% basic**
**22% applied**
**72% development**

## Credit Performance: Major Issues

**Permanence:  Planning v. budget scoring**
**Base period:  Old; source of bias**
**Coverage:  Cost / inclusiveness / flexibility**
**Rates**
**Effective rate of general credit**
**Alternative incremental credit--much of an incentive?**
**Definition of qualifiable R&D**
**Treatment of multi-organization R&D**
**Administrative cost and efficiency**

## Conclusions

**Good reasons for spending taxpayer resources to promote corporate R&D**
**The incremental R&E tax credit is an effective policy response to a general undersupply of private R&D**
**But it could be improved**