Can we all agree innovation is good?
Partisan divides are threatening to undermine legislation that should otherwise have bipartisan support. With the end of the year fast approaching, multiple proposals have been made to correct anti-innovation policies signed into law in 2017. Without the passage of corrective acts like the American Innovation and R&D Competitiveness Act, American innovation could face unfortunate setbacks, specifically for small businesses, tech and manufacturing.
After the passage of the Tax Cuts and Jobs Act (TCJA) in 2017, research and development (R&D) tax deductions were changed to offset the budgetary implications of the bill. The change prevented businesses from being able to fully deduct their R&D expenses in the tax year they occurred but instead mandated they amortize them over five years. In 2022, businesses lost 80 percent of their annual deduction for R&D. This is juxtaposed with legislation like the Infrastructure Investment and Jobs Act (IIJA) which increased investment, like the $43 billion for broadband, instead of removing it.
The effects have been disastrous for small businesses in tech and manufacturing, which are the primary drivers of innovation in the U.S. Businesses in this space need R&D to remain competitive, as new and unique technological products are the best way to break into the market. Small companies, which are often start-ups without a reliable source of revenue, rely on full deductions to stay in business. If a company had an R&D expenditure of $50,000, their deduction under the old system (assuming a 21 percent statutory corporate income tax rate) was $10,500. Now it’s just $2,100.
America’s ability to innovate gives us a competitive advantage over other nations that improves the lives of everyone through increased economic output due to lower labor inputs. America doesn’t have the most people, nor the most land, but it boasts one of the world's most pro-innovation economies. It is this innovation that is the cornerstone of American global dominance, and it is favorable policies that promote and maintain this competitive advantage.
Without these deductions, many technology startups may no longer be feasible, and even large businesses that can afford higher costs could still pull back on R&D as it no longer presents the tax advantages it used to. Put simply, creative endeavors require companies to take on greater risks. The problem is any research effort is inherently risky because no one knows whether discoveries will be profitable. For this reason, preserving R&D tax deductions is well worth the cost, as it offsets inherent risk and promotes discovery which drives economic growth.
Discontinuing these deductions is akin to taxing innovation. This is especially true when considering startups that don’t always know if they will still be around in five years to realize their R&D deduction fully. It’s unlikely any politician concerned about China, economic vitality, or consumer welfare would want to be associated with taxing innovation, which is key to alleviating all these concerns. The IIJA saw bipartisan support because it addressed many of these obvious and collectively recognizable issues, primarily in broadband. Correcting R&D tax deductions is similarly obvious.
Whether lawmakers can put aside their political differences to preserve funding for American innovation before the end of the year is still up in the air. Reports from Capitol Hill have indicated a bipartisan path exists to make this happen if compromise can be made in other areas. Waiting until 2024 would unnecessarily endanger businesses that are the engine of economic development.
Isaac Schick and Steve Pociask are with the American Consumer Institute, a nonprofit education and research organization. For more information about the Institute, visit www.TheAmericanConsumer.Org or follow us on X @ConsumerPal.