In its hurried attempt to create a tax bill capable of garnering sufficient support, the Senate unintentionally compromised a critical instrument for fostering innovation.
The research and development tax credit enables companies to deduct a portion of their expenditures on developing new and improved products. It has been especially favored by pharmaceuticals and the software sector since its introduction in 1981.
Following its permanent establishment in 2015, the Treasury Department projected it would incur a cost of $148 billion from 2017 to 2026, making it one of the most substantial tax incentives in the tax code.
The credit remained intact in both the House and Senate tax proposals, which scrapped several deductions to allow for a reduction of the corporate tax rate to 20%. It would have continued to provide corporations with further tax reductions, but that was jeopardized by a last-minute Senate decision to retain the alternative minimum tax (AMT), which conservatives have long aimed to abolish.
The AMT acts as a safeguard, preventing corporations from claiming excessive deductions and credits that could result in a zero tax obligation. Presently, corporations determine their “regular” corporate tax rate — capped at 35% minus any exclusions — and pay either that or a 20% rate calculated on an “alternative” income basis, whichever is greater. The latest Treasury analysis of the corporate AMT, dating back to 2002, indicated that it only affected about 13,000 businesses.
The House’s version of the tax bill eliminated the AMT. However, when the Senate bill was finally approved in the early hours of Saturday, the AMT was preserved. If it remains, it could negate the R&D credit’s benefits since many companies would be liable to pay a minimum tax under the AMT that cannot be further reduced by most credits or deductions.
Related: 13 ways the tax bills would affect people
“With the current proposed changes, there will be more middle-market companies falling under the AMT, losing their eligibility for R&D credits,” explains Charles Goulding, CEO of a Long Island-based tax advisory firm specializing in research credits.
This complication underscores the difficulty of reconciling the push for lower overall tax rates with the intention of using the tax framework to incentivize behaviors that are socially and economically advantageous, such as investing in research. When corporations are already paying minimal taxes, providing them with additional incentives becomes increasingly challenging.
Nevertheless, companies would still enjoy a significant tax reduction, which could free up funds for research and development. However, research indicates that when it’s less expensive to invest in R&D than distribute higher dividends to shareholders, they tend to innovate more than they might otherwise.
The R&D scenario is less concerning for smaller firms — those earning less than $50 million in the prior three years can still utilize the R&D tax credit against the AMT. Currently, 73% of businesses claiming the R&D tax credit fall below the $50 million threshold, according to the U.S. Treasury.
However, this remains an issue for larger corporations, such as Google (GOOG) and Intel (INTC), which represent the majority of the credits’ overall value. Taken by surprise, they mobilized efforts over the weekend to advocate for the removal of the AMT from the final bill.
“Keeping the AMT in reform is even more detrimental than its current manifestation,” articulated the U.S. Chamber of Commerce in a blog post on Monday morning. “This cannot be the intended outcome of a Congress that has spent years working toward a more competitive global tax framework.”
The AMT controversy isn’t the only way that tax reform could adversely impact scientific research. The proposals from the House and Senate also mandate that research expenditures be amortized over multiple years instead of allowing immediate deductions, extending the timeline for those who seek credit.
“While this issue is partly about timing, it presents a considerable disadvantage for smaller firms that need funding sooner,” states Steven Miller, national tax director at Alliantgroup.
Tax reform could also have implications for federally funded research. Federal science funding has been on a downward trajectory as a percentage of GDP since the 1970s, experiencing significant reductions during the recession. President Trump’s previously proposed “skinny budget” from the spring, which did not advance, aimed to cut funding further for departmental research, including the Department of Energy and the National Institutes of Health.
Increasing the deficit by $1 trillion isn’t likely to improve the outlook for federal science funding, cautions Joe Kennedy, a fellow at the Information Technology and Innovation Foundation, a D.C.-based think tank advocating for the expansion of the R&D tax credit.
“I believe a much more favorable bill could have been created,” Kennedy remarked. “Corporate reform is critical, but does it merit including all these additional drawbacks?”
