Can a Research and Development Tax Credit Be Properly Designed for Economic Efficiency and Equity?

Abstract

Economic growth is driven by new ideas, innovation, and technology. Since 1981, the research and development (R&D) tax credit has attempted to lower the cost of these activities through subsidies in the tax code. Theory often predicts benefits from subsidies for R&D, but policymakers are not able to properly design and implement such a tax credit. Losses owing to rent-seeking and policy uncertainty undermine the predicted benefits of a well-structured incentive program. Policymakers' inability to correctly target incentives means that programs attempting to do so harm the economy by distorting the market process. The tax code should be simplified by removing the R&D tax credit and lowering the corporate tax rate with the resulting savings. A second best alternative would make the credit permanent, eliminate credit claims on amended returns, expand the definition of qualified R&D, and use a simpler version of the credit calculation.