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Tuesday, August 28, 2012

Research Tax Credit: Current Law, Legislation in the 112th Congress, and Policy Issues

Gary Guenther
Analyst in Public Finance

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

This report describes the current status of the credit, summarizes its legislative history, discusses policy issues it raises, and describes legislation in the 112th Congress to modify or extend it. The report will be updated as warranted by developments affecting the credit.

The research credit, which has never been a permanent provision of the federal tax code, expired at the end of 2011. Since its enactment in mid-1981, the credit has been extended 14 times and significantly modified five times. While the credit is usually assumed to be a single credit, it actually consists of four discrete credits: (1) a regular credit, (2) an alternative simplified credit (ASC), (3) a basic research credit, and (4) an energy research credit. A taxpayer may claim no more than either of the first two and each of the other two, provided it meets the requirements for each.

In essence, the research credit attempts to boost business investment in basic and applied research by reducing the tax price (or after-tax cost) of that research. It is incremental in that the credit applies only to qualified research spending above a base amount. As a result, the credit’s effectiveness hinges on the sensitivity of the demand for qualified research to decreases in its cost. It is unclear from available studies how sensitive that demand is.

While most analysts and lawmakers endorse the use of tax incentives to generate increases in business R&D investment, some have some grave reservations about the current credit. 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, uneven and inadequate incentive effects, non-refundability, and an unsettled definition of qualified research.

The 111th Congress made two changes in the credit. Under the American Recovery and Reinvestment Act of 2009 (P.L. 111-5), it 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. And the Tax Relief, Unemployment Compensation Reauthorization, and Job Creation Act of 2010 (P.L. 111-340) extended the credit through the end of 2011.

A number of bills to retroactively extend and modify the credit have been introduced in the 112th Congress. They indicate that support for a permanent extension and enhancement of the credit remains as robust as ever. But the revenue cost of doing so and disagreements over how to pay for it are proving to be difficult obstacles for Congress to overcome. The Family and Business Tax Cut Certainty Act of 2012 (no bill number yet), as reported by the Senate Finance Committee on August 2, 2012, would retroactively extend the credit through 2013.

President Obama proposes in his budget request for FY2013 that Congress permanently extend the credit and increase the rate for the ASC from 14% to 17%.

Date of Report: August 14, 2012
Number of Pages: 39
Order Number: RL31181
Price: $29.95

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