In a 2012 book from Yale University Press (Innovation Economics: The Race for Global Advantage), Robert Atkinson and Stephen Ezell explore the fascinating topic of innovation in the increasingly globalized modern economy and the government policies that can promote it. The authors got my attention because they seem to relish challenging conventional wisdom, and they refuse to be pigeonholed into the usual partisan categories that frame the national tax debate.
Because large U.S. corporations do so much of our nation’s research and development, Atkinson and Ezell are ardent advocates of tax cuts for multinationals. But unlike most conservatives who readily share their views on corporate tax, they are not antitax small-government zealots. They favor increased government spending if it is directed toward infrastructure and technology. They even favor income tax increases on the wealthy if the revenue raised is used to promote business innovation. They ask: “Does anybody really believe that the better way to grow the economy is to let high-income individuals keep $65 billion more of their earnings to buy another Armani handbag or Jaguar car, instead of letting the business engines of competitiveness and innovation save $65 billion in taxes to invest in research, skills, and equipment?" Good question. But it is doubtful the Tea Partiers--who want tax cuts for individual and small business--would agree.
As part of their pro-growth agenda, Atkinson and Ezell want to expand the U.S. research credit and make it permanent. That goal is shared by nearly everybody in Washington, including President Obama (p. 13). The authors make the case as well as anyone:
Twenty years ago, the U.S. R&D credit was the most generous in the world. Today, because many nations
have instituted their own, more generous R&D tax incentives, U.S. R&D tax credit generosity has dropped
precipitously in rank, to twenty-seventh in the world. Expanding the credit would help make the United States
a more attractive location for internationally mobile R&D and lead to greater R&D investment in America.
But—despite the political consensus to the contrary—I remain unconvinced. It's not that the research credit lacks solid economic justification -- unlike most private sector spending, research produces knowledge spillovers that benefit the economy. Those "positive externalities" mean the government should provide subsidies in order to correct the free market's less-than-socially-optimal level of research spending.
The problem is not with the theory of the credit but with its execution. I have been around a while and have researched the research credit since its inception in 1981. My take is that the essential problem of the credit has only grown worse: It is impossible to find a practical definition of subsidy-worthy research in the 21st century. It is less clear than ever where corporate research ends and other innovation-inducing functions like design and software development, begin. There is little empirical work regarding why, in this modern economy in which investment spending defies categorization, some business-building activity should be subsidized and others not. This inability to target incentives to where they should go means scarce resources are inappropriately and arbitrarily assigned to certain activities, certain businesses, and certain industries while others are left in the cold. What was intended as an incentive for productive activity by clever scientists and engineers turns out to be an incentive for totally unproductive activity by clever lawyers, accountants and lobbyists.
Other problems with the credit include: (1) diminished incentive effect because of uncertainty about the definition of qualified research, about the amount of the credit because of the credit's complicated structure, and about the fate of the credit, which Congress always has on temporary status; (2) an inability to provide the incentive to small and start-up firms without tax liability (even though it is widely believed that those firms' research is particularly productive); and (3) large compliance and administrative costs.
In a new book (Extortion: How Politicians Extract Your Money, Buy Votes, and Line Their Own Pockets) Hoover Institution fellow Peter Schweizer highlights another unattractive feature of the credit: the unseemly political process surrounding the repeated renewal of its technically temporary status. Schweizer writes about Congress:
- "They trot out the R&D tax credit every few years, and it's always with their hands open, looking for money,"
says [former Microsoft executive Bob] Herbold. "It's like an annuity for them. They won't make it permanent because it doesn't make sense for them to make it permanent."