Starting this year, companies must write off their research and development (R&D) spending over five years instead of immediately deducting it from taxable income, a policy change designed to increase federal tax revenues in the near term.
As policymakers consider the future of the R&D tax change, one option on the table is to postpone the write-off of R&D spending by four years to 2026, as suggested last year in the House Build Back Better. Act. Within the ten-year budget period, a four-year delay would cost about $223 billion less than canceling write-offs entirely, but it wouldn’t boost long-term economic growth.
Canceling R&D write-offs entirely would reduce federal revenues by about $213 billion between 2022 and 2031, while increasing long-term GDP and US income by 0.1 percent.
On the other hand, delaying depreciation until 2026 would bring in about $11.2 billion over a 10-year period and would not increase GDP or US incomes in the long run. Other options to defer R&D amortization by one to three years would also increase revenues slightly, but again, with no long-term economic benefit.
Conventional revenue effect of options to defer R&D depreciation (billions of dollars) 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2022-2031 Delay in depreciation of R&D for 4 years – $56.0 – $24.3 – $ 11.1 – $4.1 $74.0 $24.3 $8.4 $0.0 $0.0 $0.0 $11.2 Delay of R&D Depreciation for 3 years -$56.0 – $ 24.3 – $11.1 $72.6 $23.7 $8.0 $0.0 $0.0 $0.0 $0.0 $12.9 Deferred R&D depreciation for 2 years – $56 .0 – $24.3 $61.4 $23.3 $7.7 $0.0 $0.0 $0.0 $0.0 $0.0 $12.1 Deferred R&D amortization for 1 year – $56.0 $43.8 $14.7 $).0 $0.0 $0.0 $0.0 $10.0
Source: Tax Foundation General Balance Model, May 2022.
Deferring depreciation by four years would slightly increase budget widow revenues compared to a $213 billion loss of revenue on permanent cancellation, largely due to timing shifts. However, a temporary tax policy would not increase GDP in the long run, as it would not affect long-term incentives. Temporary tax policies can change the timing of investment decisions, or temporarily increase investments to reduce them later, but because temporary tax policies don’t change the long-term after-tax return on investments, the long-term size of the economy is unaffected.
A temporary slowdown also carries the risk of R&D spending becoming an ongoing “tax extension”, creating uncertainty about the tax treatment of R&D as companies make investment decisions.
While extending the full deduction of R&D expenditure to 2026 may be preferable to depreciation in 2022, a superior option for economic growth and tax stability would be to permanently cancel the impending write-off of R&D expenditure.
Modeling the timing of R&D deductions and the impact on federal revenue
Switching from full R&D expenses to depreciation over five years temporarily limits the number of deductions companies can take, increasing basic income. The higher turnover of the switch is one of the reasons why the write-off of R&D is included in the Tax Cuts and Jobs Act (TCJA). Delaying the switch to redemption delays higher earnings and interacts somewhat counterintuitively with the current legal basis.
Under the slowdown, between 2022 and 2026, companies would continue to take immediate deductions rather than write them off over five years, reducing taxable income and corporate tax liability and thus lowering federal income. Between 2027 and 2031, corporations would begin to write off deductions, increasing corporations’ taxable income and tax liability and thus increasing federal income.
The following table illustrates the time difference of the delay against the background of the current regulatory baseline. Imagine that a company makes $100 in R&D investments every year. The cost of the investment will be fully deductible in 2021.
Under current law, as of 2022, only one-fifth of the investment, or $20, will be deductible each year. Since new investments are made every year, one-fifth is deductible, meaning companies will take a total of $40 in deductions in 2023 (which is equivalent to one-fifth of 2022 investment plus one-fifth of 2023 investment). The pattern continues until the 2022 investment deductions are completed in 2026, after which the total deductions allowed each year would level off. The total deductions per year would reflect one-fifth of the total investment for the current year and the four previous years.
We can compare the deductions allowed each year under the current legal basis to the deductibles allowed each year if depreciation is deferred by four years to 2026.
Early in the budget window, more deductions would be allowed if depreciation is postponed to 2026, lowering federal revenue. For example, in 2023, the deductions would be $40 under the current law, but $100 is allowed under the delay. After depreciation begins in 2026, the same phasing-in of deductions will take place over five years, increasing federal revenue. For example, by 2028, the deductions would already have built up to $100 under the current law, but only $60 under the delay option.
However, in the long run, both options lead to the same annual revenue effect — from a federal budget perspective, it’s simply a short-term shift in the timing of deductions.
Illustrate how R&D tax deductions change under current legislation and depreciation depreciation by 4 years 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 Total annual R&D investment 100 100 100 100 100 100 100 100 100 100 100 dollars Total annual deduction according to current law (5 years depreciation from 2022) $20 $40 $60 $80 $100 $100 $100 $100 $100 Total annual deductions when depreciation over 5 years is deferred to 2026 $100 $100 $100 $100 $20 $40 $60 $80 $100 $100 Difference in the value of R&D deduction at delay of amortization $80 $60 $40 $20 -$80 -$60 -$40 -$20 $0 $0
Note: The nominal value of the R&D investment and deductions are not adjusted for inflation.
Source: Author calculations.