To create new products and jobs, reform the R&D credit

Some U.S. multinational corporations are telling Congress they need special tax breaks or they’ll be forced to move their product research – along with its quality jobs – overseas. They claim they need a patent box regime – to cut taxes on their intellectual property (IP) profits – because without one they struggle to compete with companies in lower tax countries.

Unfortunately, Congress has been listening. Sens. Charles Schumer (D-N.Y.) and Rob Portman (R-Ohio) have called for creation of a patent box regime as part of the Finance Committee’s international tax-reform framework. In the House, two Ways and Means Committee members have introduced a bipartisan patent-box legislation, which Speaker Paul Ryan (R-Wisc.) supports.

{mosads}Advocates say a patent box regime will boost the development, ownership, and manufacturing of new IP products in the U.S., but there’s little proof that’s actually the case.

Only Ireland has long-term experience with a patent-box approach, because from 1973 to 2010 it exempted patent income altogether. However, Ireland ended that exemption in 2011, after it concluded that the exemption had neither stimulated innovation nor increased research. In other words, it was simply a way to avoid paying taxes.

So patent boxes would give highly profitable companies unneeded tax breaks, and likely start a flood in companies gaming the IRS by claiming that most of their income is IP-related.

Congress would be far more effective reforming the R&D credit. With the credit, if a company does more research it gets a bigger credit; if not, it doesn’t. With a patent box, once a product qualifies, it qualifies forever, whether the company does more research or not.

There’s a long list of good ideas for reforming the credit, put forward by groups as different as Citizens for Tax Justice and the accounting firm Grant Thornton. Michael Rashkin, the former CFO of Marvell Semiconductors, has called for increasing the credit to 30 percent, limiting it to research on breakthrough products — which create new industries — and then providing a low or zero income tax rate on the income if the new product’s manufactured in the U.S.

Moreover, Congress can fix the R&D credit without engaging in broad tax reform, because every extenders bill that Congress passes contains some version of the credit. That includes the one that’s likely to pass by the end of this year. The Finance Committee’s two-year extension of the credit will cost $22 billion over 10 years. By contrast, the bipartisan patent box bill in the House will cost more than $200 billion over 10 years and would need broad tax reform to cover its cost.

Patent boxes would drain billions of dollars from federal coffers each year and leave the rest of us to pick up the tab. They would favor companies with lots of IP, big pharmaceutical companies for example, over companies with little IP, including most small businesses.

If Congress wants to boost the development and manufacturing of quality IP products here in the U.S., it should reform the R&D tax credit. For all of its flaws, we know what it does and how to make it better. That’s not true of the patent box regime that some of our multinationals want.

O’Neill is the tax analyst for the American Sustainable Business Council.