continue to be proposed by industry groups and established largely through a political process that is seriously flawed.
The political process through which pre-commercial programs are often initiated is not the most efficient and equitable method of allocating federal resources or building new government programs. This is true even when considering the potential future merits of these projects. There will most likely be increasing pressure for the U.S. government to make investment decisions on funding for R&D in a wide range of technology areas. Some of these projects may be beneficial to the nation’s comparative advantage and leverage its technological strengths.
Tax incentives for R&D are often mentioned as a preferred method of promoting higher levels of industrial R&D activity in the United States. The Economic Recovery Tax Act of 1981 (P.L. 97–34) provided an initial 25 percent credit for incremental increases in corporate R&D spending. The law was later amended in the Tax Reform Act of 1986 to reduce the credit to 20 percent and revised again to include start-up ventures in the Budget Reconciliation Act of 1989.2 The credit for R&D is set to expire in June 1992.
There remains some uncertainty over the precise effect of R&D tax credits on spending for research in industry.3 There is, however, likely some benefits associated with tax credits for R&D investments as well as costs associated with any tax credit that lowers federal revenue, particularly for firms in high-technology sectors with large and growing R&D budgets (as a percentage of sales) over a number of years. Higher levels of private investment should follow the lowering of any tax, including lower costs to firms anticipating R&D tax credits in future years.4 One assessment of increased corporate R&D spending as a result of the credit indicated that in 1989, for example, $701 million more was spent on R&D in the United States.5
Although there are potential long-term benefits to R&D tax credits, we believe that these credits alone are insufficient to achieve the objective of higher overall rates of technological performance in the United States. Because R&D tax credits have not been made a permanent part of U.S. tax law, businesses are unable to plan their R&D investments with certainty. The credit may be extended or terminated every few years. Another problem with the R&D tax credit is that incentives are not available to all firms engaged in R&D activity. For example, under the law, no credit is given if current R&D spending is below a calculated base-level average over a four-year period. In addition, the possibility of selecting socially beneficial projects in pre-commercial areas is absent in measures such as the R&D tax credit.
The panel does not advocate targeting specific sectors or firms for special government financial subsidies. The United States, however, needs a mechanism to bring a higher degree of specificity than tax policy changes