Research and development (R&D) is a crucial part of technological advancement. The U.S. private sector has led the way in spending on R&D in recent years, which has led to policies designed to maximize innovation. As lawmakers are pushing to change the tax code regarding R&D, it’s first essential to consider whether this policy would have its intended effect.
R&D is how existing products are improved and new ones are created, driving innovation forward. While it can be crucial to innovation, R&D investment does not guarantee that projects will lead to new products; even if they do, market trends could shift before they ever make it to consumers.
To help mitigate this risk, governments often offer tax breaks for companies for their spending in R&D. Historically, companies could completely deduct R&D expenses from their corporate taxes in the United States. However, when looking for ways to reduce the 2017 Tax Cuts and Jobs Act deficit, Congress changed the rules to require deductions to be spread over five years in a process known in the tax code as amortization. A change that some have argued penalizes R&D investment.
In recent discussions over the tax code, there have been calls to reverse the changes made to R&D deductions to encourage more investment. Research suggests this policy may be effective.
The Tax Foundation found that tax credits increased corporate spending on R&D, with spending growing over the years. A review of the investment by companies in R&D found that in 1989, each dollar from tax credits led to between 35 and 93 cents of new research spending. By 2017, this had improved with each dollar from tax credits, leading to about four dollars of investment in R&D.
Other studies reinforce these findings. The study “Do Tax Credits Stimulate R&D Spending? The Effect of the R&D Tax Credit in its First Decade” examined how the tax credit impacted R&D spending from 1981 to 1991. The study used tax filing information to empirically explore how companies spent relative to the tax credits they claimed and where the money was spent. It found that tax credits led to a significant short-term increase in R&D spending. Overall, there is strong evidence that tax breaks for R&D research stimulate companies’ investment in R&D.
While R&D investment is risky, it is done with the expectation that it will lead to more innovative products. One difficulty in measuring this is finding a way to quantify something as nebulous as “innovation.” Many studies, including the evaluation of tax credits by the Tax Foundation, measure this in terms of the number of patents filed. While their study was more on the efficacy of tax credits for R&D research, the Tax Foundation found evidence that it can positively impact innovation. However, the relationship is not always clear, and lower marginal corporate tax rates might be better at fostering innovation.
In addition, the study “R&D Spending and Patents: Levers of National Development” found that increased spending in R&D led to more patents being filed by the companies and institutions involved. While it is difficult to measure, and results are not as precise as the relationship between tax credit programs and R&D investment, there is evidence that R&D tax credit programs lead to more investment, and spending leads to more patent filings.
Technological innovation is crucial to maintaining America’s position in the global economy, so it is crucial to determine what policies can help foster that. Studies suggest that R&D tax credits seem effective, but more research should be done to determine whether lower tax rates on corporations altogether would be more effective.
Trey Price is a technology policy analyst for the American Consumer Institute, a nonprofit education and research organization. For more information, visit https://www.theamericanconsumer.org/ or follow us on X @ConsumerPal.