Washington Report: The R&D tax credit: gone but not quite forgotten

In the recent Washington battles over federal budgets and taxes, one of the issues that has been largely lost in the shadows is also one of intense interest to top managers at laser and electro-optics companies: whether the government will renew a tax credit for research and development. That tax credit, which has existed in various forms since 1981, expired on June 30, and Congress did not act to renew it before the deadline. So company managers spent much of the year on tenterhooks waiting to see if the Republican Congress and Democratic President Bill Clinton would be able to agree on reviving the tax credit in one form or another.

Members of the Laser and Electro-Optics Manufacturers' Association (LEOMA, Pacifica CA) have rated renewal of the R&D credit as one of their four key legislative priorities for the year, along with capital-gains tax reform, construction of the National Ignition Facility, and reform of the Food and Drug Administration's handling of medical devices. Moreover, LEOMA wanted the credit made permanent, rather than simply renewed for another couple of years. Research is often planned years in advance, but a tax credit that might vanish in a year or two may do little to stimulate that research, say proponents of a permanent credit.

"Technology doesn't just occur on a six-month or a yearly basis," says David Farrell, president of Burleigh Industries (Fishers, NY). "The government should be sending a signal to businesses that they should be investing in technology." Michael Paulson, tax director for Coherent Inc. (Auburn, CA), says the evanescent nature of a temporary tax credit causes headaches in planning corporate finance. "It's nice to know whether you can anticipate the credit as you spend money," he says.

Treasury Secretary Robert Rubin also thinks the credit should be permanent. "If something is structured to be temporary, you have to decide how real it is," Rubin told reporters. And even Congress' own Office of Technology Assessment said the credit should be made permanent, rather than simply renewed for another fixed term. "If Congress decides that the tax credit meets the policy's fundamental objectives, then there is no reason—other than the revenue cost implications—for not making the credit permanent," the OTA said in one of the last reports it issued before the agency was abolished September 30 in a cost-cutting move by Congress.

And it was just those "revenue cost implications" hinted at by the OTA that made it impossible for Congress to make the tax permanent. The credit cost the government about $1.6 billion in 1992. Under congressional rules, making the credit permanent would have forced lawmakers to cut spending or raise revenue to compensate for several years' worth of the credit. But by renewing the credit only for two years, lawmakers had to find only two years' worth of money in compensation.

The credit is designed to reward extra spending by companies on research and development above and beyond what they would have spent anyway. R&D expenses in a given year were compared to a base level calculated from a company's past history. If the company's spending on R&D had increased over the base, the company was allowed to deduct 20% of that increase from its tax bill.

In its report on the credit, the OTA concluded that the tax credit was responsible for less than 2% of all spending by private companies on research and development in 1992. Small companies have benefited little from the tax credit, the OTA concluded. Firms with more than $250 million in assets were responsible for 70% of the total tax credit claimed in 1992, the agency found.

And there's little evidence that the tax credit helps mold corporate strategies in research and development, says the OTA. In fact, the agency concluded that the credit "may in some cases generate funds that can be used to speed up the pace of research, but that, overall, the tax credit does not substantially affect decisions on how much or especially where R&D resources are invested."

In short, companies see the tax credit simply as one more way to cut general costs rather than as a way to bolster their investment specifically in research. "Corporate R&D strategies in the aggregate would not change substantially if the tax credit disappeared altogether," says the OTA. [The report, The Effectiveness of Research and Experimentation Tax Credits, is available on the World Wide Web at http://www.ota.gov/publst.html -Ed.]

Although supporters often argue that the tax credit more than pays for itself by promoting research spending by companies, the OTA found that it is impossible to figure out whether that is true. For example, there is no way to measure exactly how much research results from the credit or from its benefits to society. It is also impossible to know how much research would have taken place anyway, even if the credit had not existed, says the OTA.

Alternative plan proposed

In September, the House of Representatives' Ways and Means Committee voted to offer an alternative formula for calculating the credit, which would not be as generous as the old formula but which also would be available to industries whose research programs are not growing rapidly. Under that alternative formula, a company would get a credit for 2.75% of its research expenses if the expenses were more than 2% of gross receipts, a credit of 2.2% if research expenses were between 1.5% and 2% of gross receipts, or a credit of 1.65% if research expenses were between 1% and 1.5% of gross receipts.

That proposal has received a lukewarm response. "It's small potatoes," says Farrell, who is disappointed in the failure to make the tax credit permanent. Farrell says that the government is failing to provide a strong incentive for industry to invest in important research for the future.

In a reaction that may be typical of many in the laser industry, Farrell says the credit probably would do little to lure him to increase his investment in research—but he will readily claim the credit, however paltry it might be. "Do I see it as an incentive? No. Will I take advantage of the tax laws? Yes."