Correcting the TCJA’s Mistreatment of R&D Costs

The Tax Cuts and Jobs Act (TCJA) was a worthwhile reform to the nation’s tax code. Its combination of lower tax rates, limited deductions, and better treatment of capital investment is a pro-growth change that will make the U.S. more competitive globally. But, not every change was a positive. Several provisions need to be reexamined before they inflict economic harm. Representatives Ron Estes (R-KS) and John Larson (D-CT) have introduced a bill to fix one of those provisions: the requirement that companies amortize their research and development costs. 

The United States, like most countries, taxes a company’s net income, meaning their revenue minus expenses. Getting the corporate tax base is important because the economic costs of those taxes are borne by people, such as workers, consumers, and shareholders, even if it is the corporation itself that cuts the check to the federal government. 

Currently, the federal tax code treats research and development expenses correctly. Companies that invest in innovation get to deduct those costs when they are incurred. Paying a scientist, running experiments, and creating prototypes are among the many expenses that companies can deduct under this provision. 

Starting in 2022, this will change. The TCJA says that instead of deducting these costs in the first year, companies must amortize the deductions, spreading them out over five years. At first this might not seem like a big deal, but it’s actually quite a backslide. Would you rather have $100 today or $20 per year for the next five years? Obviously, you’d pick the $100 today. Due to the time value of money, it’s worth more than $20 per year for five years. 

If this change does occur in 2022, it will have economic consequences. The policy will raise the cost of investments in research and development, meaning companies will be less likely to do R&D. That means less innovation and new technologies for the U.S. economy, leading to lower levels of productivity, lower wages, and a smaller economy.

Policymakers likely understood this impact even when the TCJA was passed, but the change was inserted to help meet budget rules in the U.S. Senate. At the time the TCJA was passed, the Joint Committee on Taxation estimated amortizing research and development costs would raise business taxes by $120 billion from 2022 to 2027. 

Now, Representatives Estes and Larson have introduced a bill to fix the TCJA’s misstep. It would stop the change from occurring in 2022. This bill represents an important change to the U.S. tax code. While the TCJA made many improvements, a few of its provisions should be revisited. Fixing the required amortization of research and development would ensure that the U.S. remains a leader in innovation in the future.