Research and development, R&D, is the generation of new knowledge. It is the oxygen of a growing and dynamic economy. In plain language, companies invest in R&D in order to increase productivity. Increased productivity is central to an ever-wealthier nation. Wealthier nations have more resources for necessary spending, including spending on national security.
Companies invest in R&D with the expectation of higher returns. But R&D spending is risky. Higher risk requires higher returns. That is a fundamental law of economics. Increasing the cost of R&D spending is counterproductive. Higher costs result in less spending and in lower long-run productivity. A tax change that was part of the Republican Tax Cuts and Jobs Act of 2017 will discourage investment in R&D in the future. Beginning in 2022, companies that invest in R&D will no longer be able to deduct their R&D expenses immediately. Rather, they will be required to amortize their costs over five years. For costs attributable to research conducted outside the United States, such costs must be amortized over 15 years. This will be the first time since 1954 that companies will have to amortize their R&D costs rather than immediately deduct those expenses.
Amortizing R&D spending is terrible policy. It will lead to a poorer America. Republicans are pushing to repeal that part of the 2017 Tax Cuts and Jobs Act that requires amortizing R&D expenses. Republicans want immediate expensing, deducting, of R&D expenditures. This would be good policy in support of future innovation.
Yet the elimination of expensing of R&D spending runs counter to the policies of the Biden administration, which wants to bolster U.S. manufacturing; yet over 58% of the benefits of R&D expensing flow to the manufacturing sector. Manufacturing is experiencing a $32 billion increase in tax liability from the elimination of R&D spending. What is the thought process of the Biden administration? R&D spending increases productivity and over time would pay for itself.
Over the short run, the $40 billion in lost tax revenues from expensing could easily be balanced with an increase in carbon taxes on imported goods from countries that are dependent on coal. Or the U.S. could institute a small tax on consumption with negative externalities, Pigouvian taxes, such as foods and drinks with high sugar content.
Democrats want to link expensing R&D to an expansion of the child tax credit. There is no reason to link the two. Expensing R&D makes the country wealthier. Expanding the child tax credit makes the country poorer. Expanding the child tax credit discourages work. It entrenches poverty. Research by professor Casey Mulligan of the University of Chicago shows that many households with two parents and two children can receive income transfers, without any work requirements, of $80,000 a year. Recent research by professors Bruce D. Meyer and Kevin Corinth supports the research of Mulligan: Expanding the child tax credit will discourage work and entrench cultures of poverty. Equally important, expanding the child tax credit would be expensive. It would increase the federal deficit by $1.6 trillion over 10 years.
Expensing R&D spending is good policy. Expanding the welfare state is bad policy.
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James Rogan is a former U.S. foreign service officer who later worked in finance and law for 30 years. He writes a daily note on finance and the economy, politics, sociology, and criminal justice.
