R&D Tax Incentives: Growth Panacea or Budget Trojan Horse?

Abstract

Research and development (R&D) activity has long held a privileged place in the U.S. income tax system and in policy debates. The premises for R&D tax incentives, however, are grounded in theory regarding a market failure for investment in R&D that does not align well with the target of U.S. R&D tax incentives. Moreover, factors contributing to innovation are now understood to include, in addition to R&D, other “knowledge-based capital” (KBC), investment in training and other human capital development, organizational processes, computer software, and architectural and engineering designs. The combination of existing R&D tax incentives, income shifting, and deferral of foreign income from U.S. tax, with intellectual property protection for successful R&D, result a poorly designed mix of overlapping benefits only loosely related to fostering innovation. Proposed “innovation box” tax incentives would add to the incoherence of the existing incentives. This article calls for a re-examination of U.S. R&D tax incentives under a framework that critically examines the scope of tax incentives and how they fit into an overall U.S. R&D and innovation incentive regime. The framework requires an evaluation whether R&D tax incentives address market failure or other nontax objectives, whether tax incentives are designed to efficiently achieve those objectives, and whether regulatory or direct expenditure alternatives would be more effective in achieving those objectives.