We have thus as yet been unable to detect reliable evidence that the credit is having a positive impact on total R&D expenditures. Our analysis is still too incomplete, however, to sustain any definite conclusion on this issue. While companies interested in tax benefits would understandably wish to see the credit extended, analytical considerations indicate that the credit will become increasingly effective in 1983, 1984 and 1985 if it is not expected to be extended. For if firms do not anticipate that the credit will be extended, the loss of future credits as a result of increasing current expenditures will be reduced by one-third for expenditures undertaken in 1983, by two-thirds for expenditures undertaken in 1984 and entirely for expenditures undertaken in 1985. By that last year, for firms with tax liability and with qualified R&D above base but less than 100 percent above base, the effective rate of credit would be raised to the full 25 percent. Without judging the issue as to whether any R&D tax credit is socially desirable, certain revisions would seem likely to improve the one currently in effect. First, while the 50 percent limitation does not apparently relate to a large proportion of R&D, its negative incentive effects can be considerable where it does come into play. To the extent that our major concern is for increasing R&D expenditures and not for distributing the benefits of reduced taxes in some more egalitarian fashion, it would appear that the 50 percent base limitation might well be removed. If it is not entirely removed, at the least, future bases should take into account the limitation on the current base. Where the 50 percent limitation is currently in force, each dollar of current qualified expenditure in excess of base might better generate only 50 cents toward increasing future bases. This would eliminate the anomaly by which, for firms in this category, each dollar increase in R&D expenditures would generate only 12.5 cents in current credit while losing 25 cents in future credits. A second significant revision, in the interest of increasing incentives, would entail eliminating or reducing the asymmetry as between firms with R&D above base and firms with R&D below base. This might of course be accomplished directly by levying a negative credit, or an additional tax, equal to 25 percent of reductions in qualified R&D spending. Since this would certainly be viewed with extreme distaste by firms affected, a more practical solution would be to combine such a tax for declining R&D with a general credit on all R&D over, say, 80 percent of base. Thus firms with decreasing R&D would lose some of the general credit and would hence be discouraged from such reductions, but might never have to pay a net tax relating to R&D. The most important and fundamental revision, however, would relate to altering the moving, company-specific nature of the base. It is this feature which results in firms generally losing dollar for dollar in future credits the amounts that they gain in current credits from increasing their R&D expenditures. Under the current law, firms whose R&D is increasing and expected to increase over base within the zero to 100 percent range, and who have and expect to have tax liabilities to be offset, in effect gain only the interest savings of postponing taxes over a three year period, rather than eliminating them.* Several methods are available which would alter this provision in the interest of increasing the effective incentive. First, the company-specific base could be retained but left fixed at, say, the average of 1980, 1981 and 1982 qualified R&D expenditures (with possibly some exceptions or adjustments for new firms). This would imply rapidly growing amounts of R&D credits over the years but would mean that the effective rate of credit would be equal to the statutory rate for firms which have current tax liabilities and are not subject to the 50 percent base limitation. It would also generally offer an incentive to firms to minimize their reductions in R&D. Somewhat more complicated to administer, but less costly in terms of tax revenues, would be a provision to start with a company-specific base, say of R&D expenditures of 1980, 1981 and 1982, but to adjust that base in accordance with national or industry movements in R&D. Thus if a firm were in an industry where R&D in 1983 grew by 10 percent, its base in calculating its R&D tax credit for 1984 would be raised by 10 percent. The credit for each firm would hence relate to increases in R&D spending over a base which is both company-specific but adjusting to movements of R&D among companies in similar situations. Unless the industry were unduly small in relation to the size of the firm-and this could be avoided by appropriate grouping of industries-each firm would have a full 25 percent effective credit as an incentive to increase its expenditures. Its increased expenditures would contribute to raising the base and reducing future credits for everybody but would 4 These interest savings would, however, prove a perpetual stream if the indicated conditions remain in effect. have a trivial effect in raising its own base and reducing its own future credits. By having the base increase on the basis of industry experience rather than companyspecific experience, we would achieve the maximum incentive impact along with the minimal Treasury tax loss associated with an incremental credit. Finally, the impact of the R&D tax credit would be increased by making it refundable or a direct subsidy rather than a credit. This would mean that the considerable number of firms in the economy not paying federal income taxes would also have an incentive to increase R&D spending. With the vastly increased depreciation deductions implicit in the accelerated cost recovery system, the investment tax credit and credits for foreign taxes, we have reached the point where many existing credits, let alone new ones, can be realized only by selling or merging firms. Unless we are to restore the corporate income tax by eliminating most or all of the existing incentives, deductions or loopholes, depending on one's view, new credits such as those for R&D would have to be refundable, regardless of taxes, to avoid significant losses of whatever incentive effects they have. Alternatively, and this may well be a better path to take, the corporate income tax as such might be eliminated, presumably with shares in real corporate earnings attributed to the individual stockholders. The business tax incentives or "tax expenditures" might be eliminated and we could readily move to direct subsidies of those private expenditures and activities which we find it in the social interest to encourage. TABLE 2.1.-OFFICE OF TAX ANALYSIS RETURNS FOR 1981: BASE, QUALIFIED R&D, CREDIT WITHOUT LIMITATIONS, LIMITATION LOSSES, TENTATIVE CREDIT, TAX LOSS, CREDIT CURRENTLY CLAIMED, AND RATE OF GROWTH OF QUALIFIED R&D OVER BASE, BY INDUSTRY TABLE 2.1.—OFFICE OF TAX ANALYSIS RETURNS FOR 1981: BASE, QUALIFIED R&D, CREDIT WITHOUT LIMITATIONS, LIMITATION LOSSES, TENTATIVE CREDIT, TAX LOSS, CREDIT CURRENTLY CLAIMED, AND RATE OF GROWTH OF QUALIFIED R&D OVER BASE, BY INDUSTRY-Continued |