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Rebuilding Manufacturing: Fixing the Dysfunctional R&D Tax Credit

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Beth Stackpole
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Rethinking R&D tax credits
Beth Stackpole   2/6/2012 7:08:44 AM
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I agree that tax incentives have to be a viable tool for enticing manufacturers to keep key R&D and manufacturing jobs on our shores. And the argument seems strong that increasing the credit to a more substantial number (should it ever pass in the Congress and the Senate--an entirely different story) could have some merit. It wasn't clear to me, however, how the curent R&D tax credit encourages companies to park R&D in overseas tax havens? If the credit is tied to U.S. manufacturing, no matter what the rate, how would it foster this overseas investment? Any one care to wade in?

 

 

williamlweaver
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Re: Rethinking R&D tax credits
williamlweaver   2/6/2012 9:51:33 AM
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I'm not an anarchist, but I do consider myself a constitutionalist. Our current situation has been developing for decades and it looks like we have reached a point where there is no longer a concept of freedom to "pursue happiness" but a "regulation of everything". Once all rights and permissions flow from an all-regulating bureaucracy, it can attempt to control the system by increasing regulations here, and providing tax incentives there. We do not have the models and knowledge of the number of variables necessary to calculate our way out of our current situation. Agile Design has taught us the Waterfall method of development doesn't guarantee success but often guarantees cost overruns and fault-ridden work product that arrives too late to be of use. Our Founders praised the Agile Design method of continuous improvement and rampant experimentation by individual stakeholders. I for one hope we can evolve our system in that direction.

Alexander Wolfe
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Re: Rethinking R&D tax credits
Alexander Wolfe   2/6/2012 1:57:29 PM
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The argument for leaving the market unregulated is good until one comes up against what China does to support its industries and technology vis a via the U.S. If China is unbalancing the playing field, as it were, then doesn't the U.S. have a right (and even a responsibility) to rebalance it by offering some levels of support, whether it's tax credits or R&D support, or whatever?

naperlou
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Re: Rethinking R&D tax credits
naperlou   2/6/2012 2:52:23 PM
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Alex, there are certianly reasons to want to do something at the governmental level to counter the Chinese government's intervention in their economy.  On the other hand, this is just like what the Japanese did over two decades ago.  At least now, the US is still very much in the running.  If the government has a role I would vote for R&D support in the form of educational support and research labs. 

Alexander Wolfe
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Re: Rethinking R&D tax credits
Alexander Wolfe   2/6/2012 3:48:58 PM
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I agree with you completely, Naperlou. Education and research support is where it's at. You mostly avoid the "picking winners and losers" argument. (Of course, you have to pick where you allocate your research dollars, but all research at the beginning is kind of by definition at the "loser" stage, since it's not productized nor profitable.) More importantly, educational support tilts towards STEM, which is what we should be doing -- incentivizing the nation's K-8 kids to learn science and math, so that sci/tech careers are at least possible by the time they get to college. Making those careers economically and socially attractive is a separate task which we also need to do.

Rob Spiegel
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Re: Rethinking R&D tax credits
Rob Spiegel   2/6/2012 3:01:57 PM
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Good point, Alex. On the other side, it has long been argued that tit-for-tat trade supports are tantamount to a trade war. I'm not sure I buy the argument that we should take the hit on the chin to avoid a fist fight. 

williamlweaver
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Re: Rethinking R&D tax credits
williamlweaver   2/6/2012 4:09:52 PM
Alex, I agree with you in that it is a sticky mess. As you know, when you poke a rigid, well engineered mechanical system, you can calculate the direction in which your push will send it. But when you poke a fluid, multiminded social system, you either get little or no response, or send it off in an unintended direction, or worst of all, you get poked back in retaliation using teeth and claws that you didn't even know the system had. Treating our economy as a momentum-conserving, Newtonian system only works when the individuals are connected rigidly, as in a well-trained military or a tyrannical dictatorship. Our economy is an information-bonded, non-Newtonian fluid. When a bureaucracy uses the term "Force" in their language, it is predetermined to fail.

naperlou
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Re: Rethinking R&D tax credits
naperlou   2/6/2012 4:23:27 PM
William, that is a great characterization. 

Charles Murray
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Re: Rethinking R&D tax credits
Charles Murray   2/7/2012 7:37:41 PM
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I agree about leveling the playing field, Alex. The trick will be to create a provision that still works in 20 or 30 years. I'm sure that the current R&D tax credit looked like a great idea in 1981.

TJ McDermott
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Re: Rethinking R&D tax credits
TJ McDermott   2/6/2012 10:01:26 AM
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I like the idea proposed in this article, but I doubt it would reverse the overseas manufacturing drain.

The cost to manufacture in the US is high because of labor costs.  US workers expect (RIGHTLY!) a safe work environment (and it is mandated by law).  China does not offer the same safety to its workers.  US workers are paid more than Chinese workers, have better benefits.  Until the disparity is truly acknowledged, there will be no change in manufacturing location.  The "global" market is a fallacy until such differences are leveled.

I am not taking a false moral stand; I'm no different than anyone else.  I know that my desire to purchase things at the lowest cost to me means I will be purchasing Chinese-manufactured items.

Set aside safety (let's assume for sake of argument all factories have the same level of worker safety).  If a factory here were to try to get away with paying its workers what Chinese factory workers earn, the newspapers here would have banner headlines with phrases like "sweat shop" and "slave labor".  If that is what it is here, then why is it not there?

Rob Spiegel
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Re: Rethinking R&D tax credits
Rob Spiegel   2/6/2012 11:02:03 AM
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Good points, TJ. Yet at some point the differential between China labor costs will even out somewhat. China is already seeing increased labor costs, particularly in plants that make goods aimed for the U.S. and Europe. That trend is sending a lot of manufacturing to Viet Nam.

Here in this country, manufacturers have negotiated labor costs down. Add shipping to the cost of China manufacturing and the gap begins to close somewhat. Add a few tax incentives and the U.S. may become an attractive place for manufacturing again.

BrainiacV
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Re: Rethinking R&D tax credits
BrainiacV   2/6/2012 11:23:30 AM
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My problem is with

making the credit applicable only to "innovative research and breakthrough products,"

Who determines if a product meets those conditions and then how soon before the companies start gaming the system so ALL products are innovative and breakthroughs.

 

The beancounters and lawyers will not rest, not with the money involved and the desire to wring the highest profits possible, irregardless of the societal and technological aspirations of the R&D credit.

apresher
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Rebuilding Manufacturing
apresher   2/6/2012 9:08:00 AM
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This is an excellent example of what has failed to happen -- an effective chain from government funding research, to product development and manufacturing.  Everyone seems to agree that we need to rebuild manufacturing but it's an area where we need effective legislation that doesn't produce unintended consequences.  Let's hope we can get it done.

George Leopold
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Re: Rebuilding Manufacturing
George Leopold   2/6/2012 10:07:46 AM
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Michael Rashkin has much more to say about the shortcomings of the R&D tax credit here:

http://www.eetimes.com/electronics-news/4235663/The-R-D-credit-doesn-t-work#76147

 

apresher
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Tax Credit
apresher   2/6/2012 10:16:50 AM
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Thanks for posting the link.  After reading it, I think we should let the tax credit die.  In practice, while the idea of the R&D tax credit is definitely appealing, the RESULTS over 30 years have been less than impressive.  It's just another example of government spending going to companies that don't need it, and spending not producing specific results.

Dave Palmer
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Process improvement
Dave Palmer   2/6/2012 1:35:07 PM
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I'm not a tax expert, but my understanding based on what I've read elsewhere is that companies can't claim the R&D tax credit for any research conducted after the start of commercial production.

If the goal is simply to promote development of new technologies, then this makes sense.  But, as George points out, there is no guarantee that companies won't use this credit to develop products in the U.S., write off the development costs, and then manufacture the products overseas.  Then the U.S. gets both less tax revenue and fewer jobs.  It's win-win for companies who do this, and lose-lose for the U.S.

But if the goal is to promote manufacturing, it might be a good idea to allow companies to claim the credit for research directed towards improving existing manufacturing processes -- provided, of course, that these manufacturing processes are located in the U.S.

Michael Rashkin's article in EETimes makes a number of other interesting points, such as how the credit disproportionately benefits large companies, who don't need it in the first place.  On the other hand, small start-up companies can't benefit from tax credits if they haven't made any profits, because they don't have any tax liability to begin with.

It seems to me like it might make sense to put a cap on the size of company which is eligible for the credit, like some income-based education credits.  Maybe, for very small companies, the credit could even be made refundable, like the Earned Income Tax Credit.

RadioGuy
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Why R&D Tax Credit does not work for small business
RadioGuy   2/6/2012 2:07:12 PM
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As the finance guy for a small company (of the "5 guys in a garage" variety) my partners asked me to look into the R&D tax credit. I quickly found that it is completely unworkable for a small business like ours, which mostly operates on a cash accounting basis.

In order to make use of incentives like this, we have to use a much larger accounting system, where we maintain separate financials for

- day to day operations

- federal tax accounting

- state tax accounting

Instead of expensing our lab costs and the labor costs of the engineers doing the development work, we have to capitalize them and manage different depreciation schedules for the federal and state acoounting systems.

In short, to benefit from such incentives, we have to create a high-overhead accountant infrastructure, and structure our business around it. This may well work for a larger company with venture finance backing, but it is completely counterproductive for a truly small business.

As far as I am concerned, we would be much better off broadening the tax base by eliminating many of these "special incentives" a.k.a. loopholes. If desired, we could make the reform revenue neutral by lowering the corporate income tax rate or (even better) expand the 15% bracket up to $500K.

Of course, such a simplification is not likely to happen any time soon, since it is the larger companies with the tax lawyers on staff that have the money to spend on lobbyists.

naperlou
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Re: Why R&D Tax Credit does not work for small business
naperlou   2/6/2012 2:44:34 PM
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RadioGuy, this tax credit is not aimed at you.  It is really aimed at large companies that spend billions on R&D.  Your argument about the broader reform is more on target.  For one thing, it would help everyone, not just the large player.  On the other hand, it make this whole debate about the R&D tax credit moot.  The fact is, we have become too tied to manipulation of our economy through taxes.  As the issues with the current R&D tax credit mentioned in this article show, we cannot respond quickly through tax policy.  We are always behind the curve when it comes to that.

benmlee2
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Get to the Root Cause
benmlee2   2/7/2012 12:25:48 PM
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These are two separate issues here. Whether there is R&D tax credit or not, manufacturing will go off shore because of economic pressure. If you want to fix that, then require worker safety regulation on Chinese made goods before import to even the playing field. You can't tax credit your way out of off shoring. Does not make economic sense.

 

As for R&D tax credit. Why is it even needed if R&D is so great for economy. Company would naturally do it anyway. Company don't do R&D because they are looking at next quarter's profit. R&D is a black hole. Stock holder demand next quarter profit so they can sell out again. Stocks are held by the minutes to days selling in and out. There are no long term investment in stock. They are dumped soon as there is a small dip or if stock holder expect a small dip.  If you have to hold on to a stock for 5 years, the mentality would be totally different. Stock holder would demand quality R&D. Not just R&D like Apple use to spend millions on for show before Steve Jobs came and got nothing out of it.

 

If you and your buddy start a business, and you invest 10k into it, you can't take the money in and out every other week. That will collapse the business. Stock gain use to be taxed at 30%. Now is only 15%. If you want to get to the root cause, give tax credit to investor who hold on to the stock for the long term. Let the market dictate R&D investment then.

RadioGuy
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Re: Get to the Root Cause
RadioGuy   2/7/2012 12:52:30 PM
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One very simple way to encourage investment rather than trading (in the stock market) would be by imposing a small transaction tax (maybe 0.25%) on every trade. This would be of no consequence whatsoever to the long term investor, yet it would make day trading unprofitable.

 

robatnorcross
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I could write a book on my gripes about this....
robatnorcross   2/7/2012 3:58:39 PM
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but I'll spare you the book version. I find it "interesting" that they asked someone from Apple to comment on this. They are a textbook example of what the problem is. They design products that have so much labor content that they can only be made in the far east. Even Corning Glass (a New York company) built a plant over there to make the front glass for the products. Steve Jobs once commented on how they changed the design at the proverbial last minute and had to re-work the production line. Things like this are due to management (using the term loosely) can impose arbitrary dead lines (under the short sighted eyes of wall street) to turn a profit in the short term. Design cycles have been made to FIT the ability to put 10,000 engineers on a problem. A perfect example is the Iphone antenna fiasco. I guess they fired the RF guy who predicted this problem in order to keep the design moving.

OK i'm finished for now. I feel much better.

JimT@Future-Product-Innovations
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Asian jobs have their own unique problems.
JimT@Future-Product-Innovations   2/8/2012 7:45:08 AM
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I think the current outsourcing trend will (and is currently) reversing, not because of a modified Tax Credit, but because of multiple other Asian issues.  It's been ten years since we collectively jumped on the outsource bandwagon, and look how the playing field has leveled in that time.  Asia is not the low cost haven is was in 2000 and most teams I work with consider Domestic vs. Asian sourcing when placing programs. For those who have spent time and dollars on projects with 12-hour time zone differentials, experience has taught there are other factors besides labor cost that are bringing jobs back into the US.

Rob Spiegel
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Re: Asian jobs have their own unique problems.
Rob Spiegel   2/8/2012 3:33:41 PM
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I agree, Jim. The manufacturing rush to Asia will look temporary historically. Asian costs are increasing, North American manufacturing costs are coming down (through advanced automation and labor give-backs). Logistics costs (and snafus) will tip manufacturing back to the region of the market. 

angeldowrothy
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RE:
angeldowrothy   12/21/2013 8:37:38 AM
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The tax credits should be increased as sometimes situations make us go deep down in debt, till how much can some one rely on Turbotax to get discounts and deductions and other benifits.

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