The bulb suddenly is flickering for many of America’s most innovative businesses — life sciences companies, pharmaceutical developers, software developers and a wide range of manufacturers. It’s especially troubling because we depend on these businesses to light the way for growth, ingenuity and global competitiveness.
The threat to those imperatives is a change to a tax law originally enacted nearly 70 years ago that provided a key incentive for American innovation and helped solidify the United States’ position at the heart of the global economy.
Companies can no longer immediately deduct all their research and development expenses from the income on which they are taxed. Instead, they must amortize these costs over five years (or 15 years for R&D activities abroad).
The change was written into the Tax Cuts and Jobs Act in 2017 to help offset the cost of tax reductions in the bill, such as the reduction in the corporate rate to 21 percent and the enactment of the 20 percent deduction for certain unincorporated businesses.
At the time TCJA was enacted, many hoped that Congress would revisit this change to the tax treatment of R&D expenses before it took effect. But despite broad bipartisan support for reinstating full and immediate deductibility — exemplified by a bipartisan bill introduced on March 16 proposing such a fix — the provision continues to be a bargaining chip in congressional negotiations instead of a standalone priority.
The immediate consequence of congressional inaction is a higher 2022 tax bill — sometimes well into the millions of dollars — for countless businesses whose operations center on product development and technological advancement.
To be clear, businesses don’t perform R&D primarily to lower their income tax bill; rather, they innovate to grow, and tax incentives make it easier for them to manage their costs. Immediately deducting expenses, as opposed to the new requirement to spread them over five years, would increase liquidity in the short term, freeing up additional resources to invest in research — a benefit policymakers should not underestimate amid elevated inflation and interest rates.
With the new tax treatment in effect, the outlook is darkest for relatively small and immature businesses, which often claim losses in their early stages while they focus on product development. Increased tax costs are forcing these businesses to limit or eliminate R&D initiatives, lay off employees responsible for innovation and scramble for cash to pay the bill. Medium-sized businesses also have been hit especially hard.
We are working with these businesses every day. A company developing laboratory microscope technology that could combat the next pandemic is now determining whether it can proceed. A housing materials manufacturer has ceased efforts to make its windows and doors more durable and energy efficient. A software developer paused all plans for new offerings, instead reorganizing to support existing products.
These real-life examples add up to an economic disadvantage for the United States compared to our global competitors. China, among them, allows companies to deduct 75 to 150 percent of their R&D costs in the year they occur via a recently enhanced so-called “super deduction.” In the last two years, the Chinese government has increased and extended deductions designed to incentivize the country’s manufacturers and technology-based small- and medium-sized enterprises.
With weaker R&D incentives in the United States, some promising trends are in jeopardy. In 2020, U.S. companies spent $538 billion on R&D domestically, a 9.1 percent increase from 2019, according to the National Center for Science and Engineering Statistics. Companies with fewer than 250 employees spent $56.4 billion in 2020 and accounted for between 10-11 percent of U.S. R&D spending each year from 2017-2020.
Canceling the R&D amortization requirement and restoring immediate deductibility would increase U.S. GDP by about 0.1 percent, increase wages by almost 0.1 percent and create approximately 19,500 jobs, according to a Tax Foundation estimate in 2021. The manufacturing industry’s collective tax liability in 2023 would be $31.7 billion lower, the Tax Foundation estimated in late 2022.
By those estimates, undoing the amortization requirement would cost the federal government $108 billion between 2022-31. Is that price worth paying for American growth and competitiveness?
You don’t hear about sticker shock from lawmakers on either side of the aisle because the price is not the obstacle. In fact, there’s strong support from both parties to reinstate immediate deductibility. A bill recently introduced in the Senate is co-sponsored by seven Republicans, five Democrats and one independent.
But this has become a matter of priorities and politics. Republicans want to restore immediate deductibility. Many Democrats also support a fix; however, some see this as an opportunity to negotiate a permanent expanded child tax credit.
To that end, Republicans have made clear that they are not going to agree to the terms of the child tax credit as it was expanded during the pandemic. But there are realistic compromises that don’t cost extraordinary amounts of money.
The Democrats could agree to reinstate a work requirement. The amount of the credit could be lowered from $3,600 per child (or thereabouts, depending on age) to around $2,500. Or perhaps the credit could be limited to a specified number of years.
Continuing this stalemate only undermines our economic interests domestically and globally. The stakes are too high to treat R&D as a bargaining chip instead of the end game.
Small and midsize businesses, in particular, need our divided Congress to compromise and restore immediate deductibility. Many are contending with threats to core operations. Without product diversity or access to financing that may help larger companies limit the damage from an increased tax bill or decreased R&D capabilities, more nascent businesses will arrive faster at a point of desperation.
For nearly 70 years, we had a tax incentive that helped innovative American businesses shine. Bipartisan legislation to restore immediate deductibility for R&D expenses has been introduced. We need Congress to act and flip the switch back on.
David J. Kautter was assistant secretary, tax policy, of the U.S. Department of the Treasury from 2017-21. He served as acting commissioner of the IRS for 11 months ending in 2018. In 1979, he drafted the first federal R&D tax credit bill, which became law in 1981 as an incentive to supplement the immediate deductibility of R&D expenses. He is now the federal advisory tax leader at RSM US LLP.