A Permanent R&D Credit - Will It Happen this Year?

4/29/14 House Ways & Means Committee Markup Meeting

The federal income tax credit for certain R&D expenditures (primarily wages and supplies) has been a temporary provision since first enacted in 1981 (it first expired in 1985 and has been extended about 14 times since). The temporary credit seems odd considering the following:

• Every President and probably most legislators since 1985 have called for a permanent credit.
• Unlike most other credits, there is economic justification for the credit beyond only incentivizing R&D in the U.S. There are spillover effects from a company's R&D activity and the credit helps compensate for them.
• Most countries not only have a lower corporate statutory income tax rate, but also research and innovation incentives on a permanent basis.
• Our global economy enables companies to take advantage of permanent incentives in other countries and then the US loses the R&D work. R&D work involves the need for a highly educated and compensated workforce, something good for our economy and society.
• A permanent credit would enable companies to better plan for its use likely resulting in more R&D work in the US. It is impossible to plan to fully utilize the credit when it continues to expire with renewal uncertainty (once in the late 1990s, it was left to expire for one year).
• A permanent credit means there is no need for renewal of it which often happens retroactively and diminishes the incentive value of the credit.

But, today, there is no research credit because it expired at the end of 2013.

On April 29, 2014, the House Ways and Means Committee held a markup meeting to look at just six of the 57 provisions that expired at the end of 2013. One of these proposals was H.R. 4438 to make the research tax credit permanent. It would also make significant changes including the following:

• Repeal the "regular" credit that uses the 1984-1988 base years and only keep the alternative simplified credit that looks at qualified research expenditures in the past three years for the base.
• Increases the simplified credit percentage from 14% to 20% (10% in the first year the business has QRE).

The proposal passed by the Ways and Means Committee did not include some items just recently proposed by Congressman Camp in his Tax Reform Act of 2014 discussion draft, released February 2014. The discussion draft (pages 73-74) proposed to exclude supplies from the credit as well as not have it apply to software development costs. He also proposed earlier to only increase the simplified credit to 15% (from 14%).

The Joint Committee on Taxation estimates the cost of the modified, permanent credit at about $15 billion per year (JCX-44-14).

For a list of the other five expired items the committee voted to make permanent, click here.

Next steps?  The House needs to vote and the Senate Finance Committee needs to review and the Senate vote.  Then if both the House and Senate have approved, it would go to President Obama for signature. I think if it all goes as separate bills, the research credit has a better chance of being made permanent because President Obama has also called for a permanent credit (see FY2015 Greenbook, page 12).

The issue of whether renewing expired provisions requires revenue offsets must be resolved.  The House Ways and Means Committee has posted a piece from the Heritage Foundation (4/28/14) that says renewing an expired provision is not a tax cut so it does not need a revenue offset for revenue neutrality. The issue relates to assumptions made (or not made) in the CBO baseline and estimates of discretionary spending. Congressman Camp seems to be following the assumption that revenue offsets are not needed as there are none for the permanent tax credit and the Heritage Foundation article is posted to the committee's website.  Others say that extending tax cuts (such as a credit) requires revenue offsets (tax increases or spending cuts) to be revenue neutral. See articles from the Center for Budget and Policy Priorities (CBPP) and the Committee for a Responsible Federal Budget (CRFB). I agree with the CBPP and CRFB. The CBO baseline assumes that expired provisions permanently expire. Also, one of several reasons why these provisions are temporary rather than permanent is that when a tax cut is in only one year of a ten-year budget, it costs less than if it were in for each of the ten years. Thus, bills with these items only in as temporary measures don't need as much revenue offset.

We'll see what happens with H.R. 4438. It certainly has support and I believe it can also be down outside of tax reform as there are reasons that justify having a research tax credit (see a few more in testimony on incentives for innovation I delivered to the Senate Finance Committee in 2011).

What do you think?