The leading economies of the future will be driven by technologies that are now only in research and development stage, as those technologies diffuse across production processes and types of products that are available. At some level, I think pretty much everyone knows this. But policymakers often don’t seem to take the next logical steps, which are to emphasize incentives for research and development spending, along with supporting workers and firms as they adapt to the innovations still to come. Mary Cowx, Rebecca Lester, and Michelle Nessa focus on one aspect of these issues: how tax policies affect incentives for business R&D spending, in “Bad breaks: Why US tax policies put innovation at risk” (Stanford Institute for Economic Policy Research, May 2025). The authors write:
There are two types of innovation tax incentives: input- and output-based incentives. Input-based incentives are tied to amounts spent on investing in innovation, including R&D deductions and credits. Output-based incentives provide lower tax rates on income earned from a firm’s innovation assets — a system popular among several European countries and known as “patent boxes.” The U.S. primarily has input-based incentives. The two largest U.S. R&D tax incentives are the R&D tax deduction and the R&D tax credit. Together, these benefits provided U.S. companies with more than $100 billion in tax savings in 2021, the most recent year with available data (IRS 2024).
Adding these various tax provisions together, the authors show “the value of R&D tax subsidies available for large, profitable companies in countries around the world. Twenty years ago, the U.S. provided a similar amount of incentives as other OECD countries. Now, however, the level of U.S. incentives is roughly 20 percent of the OECD average and less than 10 percent of what China offers.”
“What’s going on here in the US tax code? Traditionally, going back to 1954, the money that a company spent on R&D was “expensed”–that is, the company could treat R&D spending as an expense in that same year, which reduced the taxes the company owed. In contrast, if a company bought a piece of machinery that would pay offer over time with increased profits before eventually wearing out, the standard tax treatment was that that only some of the cost of the machinery could be treated as an expense each year, as the physical equipment depreciated over time. But this tax provision was changed in 2022:
In tax year 2021, U.S. corporations deducted more than $327 billion of R&D costs on their tax returns, resulting in $69 billion in tax savings (IRS 2024). … Prior to 2022, U.S. companies could immediately deduct 100 percent of their R&D expenditures in the year incurred. This deduction significantly reduces the after-tax cost of innovation. However, beginning in 2022, U.S. companies are now required to spread the deduction for domestic R&D expenditures over a five-year period, meaning they can deduct only 10 percent of their R&D costs in the year of the investment. … Companies cut their R&D investment and their numbers of employees working on R&D in response to this new policy. The most research- intensive public companies in our sample cut their R&D by 11.6 percent in the first year alone.
There is also a tax credit for research and development spending. As the authors point out, there is strong evidence that this tax credit offers further encouragement to corporate R&D spending, but with some limitations. For example, the R&D tax credit is based on the gain in R&D spending compared to the past, which creates issues of how to measure and compare R&D over time. Also, a tax credit only pays off for a firm that is making a profit–and many innovative R&D-intensive small firms are not yet making a profit.
Yes, there are also recent tax subsidies through laws like the Chips and Science Act of 2022 (CHIPS) and the Inflation Reduction Act of 2022 (which actually focused on green energy). But these tax subsidies are mostly for production using existing technology, not for supporting R&D.
While the US has been reducing tax incentives for R&D spending, other countries have been ramping up. While the US tax rules as of 2022 require that R&D expenses be spread over five years, countries like Brazil and China are offering “super-deductions” for R&D, where a company can write off 200% of its R&D spending. Countries like teh United Kingdom and Netherlands have “patent boxes” in their tax laws, which means that income earned from innovation is taxed at a lower rate: “The U.K.’s patent box, for example, reduces the corporate tax rate on qualifying innovation income from 25
percent to just 10 percent — a cut of 60 percent.”
Corporate taxes serve multiple goals. For example, if corporate taxes didn’t exist, they people could invest corporations and let their money grow untaxed for years or decades. But the way in which corporate taxes are constructed also creates incentives for corporate behavior. Lower incentives for US corporations to pursue R&D is not a good long-term bet on America’s economic future.
