Starting this year, companies must write off their research and development (R&D) expenses over five years rather than deduct them immediately from taxable income, a policy change aimed at boosting federal tax revenue in the short term.
As policymakers consider the future of changing R&D taxation, one option on the table is to delay the amortization of R&D expenses by four years until 2026, as proposed in the House Build Back Better Act. Last year. In the 10-year budget window, a four-year delay would cost about $223 billion less than outright write-off of depreciation, but it would not increase long-term economic growth.
The outright cancellation of R&D depreciation would reduce federal revenues by approximately $213 billion between 2022 and 2031, while increasing long-term GDP and US incomes by 0.1%.
Delaying depreciation until 2026, on the other hand, would return about $11.2 billion over 10 years and would not increase long-term GDP or US incomes. Other options to delay R&D amortization by one to three years would also slightly increase revenue, but again, without long-term economic benefit.
|Defer R&D amortization 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|
|Defer R&D amortization 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|
|Defer R&D amortization 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|
|Defer R&D amortization for 1 year||-$56.0||$43.8||$14.7||$7.5||$0.0||$0.0||$).0||$0.0||$0.0||$0.0||$10.0|
Source: Tax Foundation General Equilibrium Model, May 2022.
Delaying amortization by four years would slightly increase revenue for the budget widow compared to a $213 billion revenue loss if canceled permanently, largely due to schedule changes. A temporary fiscal policy, however, would not increase long-term GDP because it would not affect long-term incentives. The temporary tax policy may change the timing of investment decisions or temporarily increase investment only to drop it later, but since the temporary tax policy does not change the long-term after-tax return on investment, the long-term size of the economy is not affected.
A temporary delay also creates a risk that R&D spending becomes a permanent “tax extension,” creating uncertainty about the tax treatment of R&D when companies make investment decisions.
While extending the full deduction of R&D expenses through 2026 is preferable to allowing depreciation in 2022, a superior option for economic growth and tax code stability would be to permanently cancel future amortization of R&D expenses.
Modeling the timing of R&D deductions and impact on federal revenues
Moving from a full charge for R&D costs to a five-year amortization temporarily limits the amount of deductions companies can take, increasing base revenue. The higher revenue from change is one of the reasons R&D depreciation was included in the Tax Cuts and Jobs Act (TCJA). Delaying the move to depreciation delays the increase in revenue and has a somewhat counter-intuitive interaction with the current baseline of the law.
Under the deferral, between 2022 and 2026, businesses would continue to take immediate deductions instead of amortizing them over five years, which would reduce taxable income and corporate tax payable and thereby reduce federal revenue. Between 2027 and 2031, businesses would begin amortizing deductions, which would increase taxable income and corporate tax liability and thereby increase federal revenue.
The following table illustrates the time difference of the delay in the context of the current law baseline. Imagine a company making $100 of R&D investment every year. The investment cost is fully deductible in 2021.
Under current law, beginning in 2022, only one-fifth of the investment, or $20, is deductible each year. As new investments are made each year, one-fifth is deductible, meaning that in 2023 companies take a total of $40 in deductions (reflecting one-fifth of the 2022 investment plus one-fifth of the 2023 investment). The trend continues until the deductions for the 2022 investment are completed in 2026, at which time the total deductions allowed each year would level off. The total deductions each year would reflect one-fifth of the total investment for the current year and the previous four years.
We can compare the deductions allowed each year under the current law basis to the deductions allowed each year if depreciation is delayed four years to 2026.
At the start of the budget window, more deductions would be allowed if depreciation is deferred until 2026, which reduces federal revenue. For example, in 2023, deductions would total $40 under current law, but $100 is allowed under the time limit. After depreciation begins in 2026, the same phase-in of deductions occurs over five years, increasing federal revenue. For example, in 2028, deductions would have already reached $100 under current law, but would only be $60 under the deferral option.
In the long run, however, both options have the same effect on annual income – from the perspective of the federal budget, it is simply a short-term change in the timing of deductions.
|Total annual investment in R&D||$100||$100||$100||$100||$100||$100||$100||$100||$100||$100|
|Total annual deductions under applicable law (5-year amortization from 2022)||$20||$40||$60||$80||$100||$100||$100||$100||$100||$100|
|Total annual deductions when 5-year depreciation is deferred to 2026||$100||$100||$100||$100||$20||$40||$60||$80||$100||$100|
|Difference in value of R&D deductions in case of delayed amortization||$80||$60||$40||$20||-$80||-$60||-$40||-$20||$0||$0|
Note: The face value of R&D investment and deductions are not adjusted for inflation.
Source: Author’s calculations.