Rebuilding Manufacturing: Fixing the Dysfunctional R&D Tax Credit

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.