Tax code

To stimulate investment in R&D, stop penalizing it in the tax code

In his State of the Union Address, President Biden has called for a global level playing field for research and development (R&D) by increasing federal R&D spending, in particular by calling on Congress to pass the bipartisan U.S. Innovation and Competition Act (USICA). While the USICA proposes to increase public investment in R&D, it does not address a recent tax change that penalizes private investment in R&D. Policymakers should prioritize increasing investment in private sector R&D by permanently reversing R&D depreciation this year, ensuring that the United States can continue to lead R&D.

When policymakers were designing the Tax Cuts and Jobs Act (TCJA) of 2017, they were looking for sources of revenue within the 10-year budget window. One of the revenue generators they selected changed the way companies can deduct R&D expenses. Before the TCJA, companies could deduct the full cost of R&D investments immediately, but starting in 2022, companies would have to write off R&D investments, spreading the deductions over five years. R&D produced abroad is now deducted over 15 years.

The purpose of the change was to reduce the bill’s impact on the deficit, but it came at the cost of a long-term negative economic impact. Spreading deductions over time discourages investment as it means businesses cannot fully deduct their investments in real terms— inflation and the time value of money erode the value of deductions in future years.

Requiring R&D expenses to be written off has made the United States less competitive. No other developed country requires companies to spread R&D deductions over several years. Instead, companies typically receive up-front deductions as well as generous subsidies. For example, China allows the immediate deduction of R&D expenses and provides “great deductions” to encourage investment in R&D. Among the countries of the Organization for Economic Co-operation and Development (OECD), 20 provide special and preferential deduction rules for R&D expenses.

The United States should at least ensure that the tax code does not penalize domestic R&D, which can be addressed by reinstating immediate spending. We find that permanently canceling the depreciation of R&D expenditures would increase long-term GDP and long-term US income (GNP) by about 0.1%, or about $27.5 billion per year in dollars of 2022.

The Senate passed USICA and his accompanying bill in the House is a place where policy makers can consider writing off R&D depreciation. The proposals would increase spending by government agencies on R&D, but notably lack tax changes to end the bias against private investment in R&D. If R&D expenditures are included in the USICA, they should be made permanent to provide certainty for companies making long-term investments and to increase long-term economic growth.

Economic and revenue effects of the permanent cancellation of R&D depreciation, 2022-2031
Change in GDP +0.1%
Change in GNP +0.1%
Change in share capital +0.2%
Change in wage rate +0.1%
Effect on conventional income over 10 years -$131.3 billion
Effect on dynamic earnings over 10 years -$107.9 billion

tax foundation, Options for Reforming the US Tax Code 2.0Tax Foundation, April 19, 2021,