As the debate over how to revive US manufacturing heats up, tax and other proposals are emerging to provide incentives for technology companies to boost their investment in innovative research that could foster new engines of economic growth.
One of the most intriguing proposals comes from a tax expert who has worked for computer and chipmakers, including Apple and Marvell Semiconductor. Michael Rashkin, author of The Practical Guide to Research and Development Tax Incentives, says a key tax incentive for tech companies, the R&D tax credit, is too complex, has not increased R&D spending, and needs to be overhauled.
Rashkin argues that the R&D tax credit in its current form isn’t working. Created in 1981, the provision gives US companies a tax break on R&D expenses. Other R&D incentives include faster writeoffs of equipment and favorable tax treatment for stock option costs.
Those provisions don’t address what’s ailing US innovation and manufacturing, Rashkin says. “American companies used to develop and make their products in the US, but we are now witnessing a debilitating outsourcing cycle where taxpayer subsidized R&D is used to create overseas jobs,” he told the Senate Finance Committee during a September 2011 hearing on reforming the R&D tax credit.
According to Rashkin, the current tax structure works like this: Government agencies like the National Science Foundation fund basic research; then tax incentives and other subsidies are used to encourage product development, often based on federally funded basic research. Rather than investing in US manufacturing of new products, Rashkin told Congress that the structure encourages US companies to “park the resulting intellectual property in tax havens.”
The result is that US companies attracted by foreign incentives and low US taxation end up outsourcing manufacturing jobs. This means fewer US jobs and little tax revenue, two of the primary justifications for the R&D tax credit.
Rashkin says reform of the “dysfunctional” R&D tax credit should begin by raising the credit to 30 percent from the current rate that he says is only a few percentage points of the total cost of R&D. Another proposed reform is making the credit applicable only to “innovative research and breakthrough products,” Rashkin adds.
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?
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.
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.
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?
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.
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.
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.
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.
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?
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