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Amid Cuts, Invest in Innovation

The U.S. Capitol building is pictured as lawmakers return from the Christmas recess in Washington (REUTERS/Mary Calvert).

Contrary to the claims of some politicians and pundits, we can’t cut our way to a strong economy. We need to get our fiscal house in order, to be sure. But we also need to invest in those key areas that can help boost the nation’s growth, which is still the best way to erase the debt.

Which is why, in the midst of its fiscal struggles, Congress should move forward on the permanent authorization of a simpler and more generous research and experimentation (R&E) tax credit.

Since 1981, the R&E tax credit has helped guard against one of the foremost enemies of innovation: underinvestment. The first of its kind, this credit encouraged firms to commit funds to research and development activities and sent a clear signal to the world that the U.S. placed a high priority on the continued strength of its innovation-driven economy.

Left to their own devices, private firms tend to underinvest in R&D because they are unable to capture all of the benefits of their investments. The spillover effects of research and development—those positive externalities such as knowledge transfer and information sharing that encourage further innovation and help strengthen regional industry clusters—mean that an individual firm’s R&D investments will likely benefit not just the company itself but the industry as a whole.

The R&E tax credit helps counteract this tendency to underinvest. By effectively reducing the cost of private-sector R&D, the credit encourages companies to spend more on research activities than they otherwise would.

Over the past three decades, countries throughout the world have adopted their own policies to stimulate private R&D investment, many of which now outpace the R&E tax credit. Indeed, the Information Technology and Innovation Foundation (ITIF) found that the U.S. now ranks 27th in terms of R&D tax incentive generosity. Even more troubling, the U.S. now ranks fourth out of 40 countries in innovation-based competitiveness and second to last with regard to progress over the last decade.

Expanding the credit from 14 percent to 20 percent would improve the credit’s competitiveness in the global marketplace while also producing an estimated $66 billion increase in annual GDP and at least 162,000 new jobs—both of which would go a long way towards setting the U.S. economy back on track.

In addition, a permanently authorized R&E tax credit would bring an end to the repeated expiration / reauthorization cycles that now foster uncertainty about the future tax climate and, in turn, discourage long-term R&D investments. By introducing a degree of predictability, a permanent credit would encourage companies to engage in long-term planning and undertake R&D projects with longer timelines.

And simplifying the calculation of the credit would lower administrative costs for firms seeking the credit and for the IRS in determining qualification and compliance.

From increased innovation and first-mover advantages to job growth and higher productivity, the potential benefits of the R&E tax credit underscore why it is particularly deserving of federal investment. And with support spanning the political spectrum, permanent authorization of the R&E tax credit offers a rare opportunity for bipartisan action. So as Congress and the president sort out a solution to the austerity crisis, they should also seize this moment to strengthen the economy by simplifying, expanding, and making permanent the R&E tax credit.

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