Research Tax Credits: An Important Tool

Abstract

In his News & Analysis piece on the lapse of the U.S. research and experimentation (R&E) tax credit (“U.S. tax credit: Boondoggle or boon for research?,” 3 January, p. [13][1]), D. Malakoff quotes Citizens for Tax Justice advocates who argue that we might be better off “if Congress killed the credit and used the money for targeted, direct research grants.” While we do not defend the credit in its current form, we believe (and have recently explained) that optimal innovation policy requires a mixture of financial incentives for research and development, including tax credits as well as other tools such as grants, patents, and prizes ([ 1 ][2]). Targeted research grants are effective only when government decision-makers can obtain reliable information about the costs and benefits of potential research projects. For many new technologies, the government is at a comparative disadvantage when it comes to picking winners, and market signals may provide a more accurate proxy for social benefits. Under these circumstances, incentives such as tax credits may be preferable to grants. Because tax credits only refund a portion of research expenses, they are generally used in combination with private investment and do not displace the role of markets in allocating resources. Tax credits might appear inferior to patents as a way to leverage private information because tax credits impose a higher cost on the federal budget, but this disadvantage is illusory. The reward to innovators from patents comes from higher prices on patented products, and these higher prices impose a “shadow patent tax” on consumers comparable to the more transparent taxes that fund tax credits, grants, or prizes. This is not to say that the current implementation of the R&E tax credit is ideal, but we think that tax credits play an important role in our innovation policy portfolio. 1. [↵][3] 1. D. J. Hemel, 2. L. L. Ouellette , Texas Law Rev. 92, 303 (2013). [OpenUrl][4] [1]: /lookup/doi/10.1126/science.343.6166.13 [2]: #ref-1 [3]: #xref-ref-1-1 View reference 1 in text [4]: {openurl}?query=rft.jtitle%253DTexas%2BLaw%2BRev.%26rft.volume%253D92%26rft.spage%253D303%26rft.genre%253Darticle%26rft_val_fmt%253Dinfo%253Aofi%252Ffmt%253Akev%253Amtx%253Ajournal%26ctx_ver%253DZ39.88-2004%26url_ver%253DZ39.88-2004%26url_ctx_fmt%253Dinfo%253Aofi%252Ffmt%253Akev%253Amtx%253Actx