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.
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.
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.
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.
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?
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.
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.
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.
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.
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?
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