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Wednesday, September 29, 2010

Research and Experimentation Tax Credit: Current Status and Selected Issues for Congress

Gary Guenther
Analyst in Public Finance

Technological innovation is a major driving force behind long-term economic growth, and research and development (R&D) serves as the lifeblood of this innovation. The federal government supports business R&D in a variety of ways, including a tax credit for a company’s increases in qualified spending on research over a base amount.

This report describes the current status of the credit, summarizes its legislative history, discusses the key policy issues it raises, and describes legislation in the 111
th Congress to modify or extend it. The report will be updated as needed.

The research tax credit, which has never been a permanent provision of the federal tax code, expired at the end of 2009. Since its enactment in mid-1981, the credit has been extended 13 times and significantly modified five times. While the credit is often referred to as a single credit, it actually consisted of four discrete credits in 2009: (1) a regular credit, (2) an alternative simplified credit (ASIC), (3) a basic research credit, and (4) an energy research credit.

The research tax credit is designed to boost business investment in what might be described as basic or applied research by reducing the after-tax cost of that research above a base amount. So it is fair to say that the credit’s effectiveness hinges on the sensitivity of the supply of qualified research to changes in its cost. Although many analysts and lawmakers support the use of a tax incentive to generate increased business R&D investment, the same cannot be said of the current credit, whose effectiveness has been widely criticized. Critics contend the credit is not as effective as it could be because of certain flaws in its design, such as a lack of permanence and uneven and inadequate incentive effects.

After the research credit expired at the end of 2007, the 110
th Congress retroactively extended it through 2009 under the Emergency Economic Stabilization Act of 2008 (P.L. 110-343). The act also increased the rate for the ASIC from 12% to 14% and repealed the alternative incremental research credit (AIRC) for 2009 only.

As part of legislation to revive a slumping economy, the 111
th Congress has made one notable change in the research tax credit. The American Recovery and Reinvestment Act of 2009 (P.L. 111-5) extended through 2009 a provision that gave corporations the option (which first became available in 2008) of claiming a limited refundable tax credit that year for unused alternative minimum tax and research tax credits from tax years before 2006, instead of any bonus depreciation allowance they could take. Still, the credit expired at the end of 2009, and the odds that it will be extended again before the end of the current Congress appear less than favorable, despite broad bipartisan support for the credit.

An extension of the credit through 2010 was included in a so-called tax extenders bill (H.R. 4213) passed by the House on December 9, 2009. But after a series of changes in the legislation in both the House and Senate, the version of the bill that was enacted in late July had been stripped of all tax provisions. More than 20 other bills that would extend (in some cases permanently) or enhance the research tax credit have been introduced.

President Obama has expressed support for a permanent extension of the credit, both in his budget request for FY2011 and in a recent proposal to inject additional stimulus into the economy. The proposal would also repeal the regular credit and increase the maximum rate for the ASIC from 14% to 17%.

Date of Report: September 10, 2010
Number of Pages: 35
Order Number: RL31181
Price: $29.95

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