About | HeinOnline Law Journal Library | HeinOnline Law Journal Library | HeinOnline

LOG IN
LOG IN


1 [1] (April 9, 2018)

handle is hein.crs/govzey0001 and id is 1 raw text is: Congressional Research Service Informing the legislative debate since 1914 S Updated April 9, 2018 The 2017 Tax Law (P.L. 115-97) and Investment in Innovation Technological innovation refers to the often lengthy, uncertain, and convoluted process of bringing new technologies to the marketplace and their adoption by many consumers and companies. Numerous studies have shown that innovation serves as the primary engine of long-term growth in real income per person, mainly by increasing the productivity of a nation's capital stock and labor force. Among the key players in the innovation process are large established companies that invest substantial amounts in research and development (R&D), small start-up (or entrepreneurial) firms seeking to commercialize specific new technologies, and companies that invest in advanced capital assets for use in their operations. Investment in Innovation and Federal Policy In a market economy, the main driver of technological innovation is private investment in R&D and in new capital assets that incorporate advanced technologies (e.g., robotics). Companies making such investments seek to seize, sustain, or enlarge a competitive advantage by being the first to sell or use new and improved products, more efficient production methods, and more effective ways of conducting a business. In theory, companies that engage in R&D are likely to invest too little in that activity, relative to its potential economic benefits. There are two main reasons for this presumed underinvestment. First, R&D (especially basic research) typically generates economic benefits that are not fully captured by the firms financing the R&D investments. Instead, these benefits typically spill over to other firms and consumers. In addition, the difficulties faced by many small entrepreneurial firms in raising funds to undertake R&D can further suppress private R&D investment. Economists consider underinvestment in R&D a market failure. As a result, they recommend that governments try to boost private R&D investment through a variety of policy initiatives, including research grants and tax incentives. The vast share of domestic business R&D investment goes into development projects. In 2015, according to a survey by the National Center of Science and Engineering Statistics, foreign- and U.S.-based businesses spent $355.8 billion on domestic R&D. Of that amount, $21.8 billion went to basic research (6%), $56.5 billion to applied research (16%), and $277.6 billion to development (78%). Such a distribution is to be expected, since the largest risk of failure and spillover benefits attaches to basic research, while development projects tend to have the lowest risk of both outcomes. Taxes can affect the domestic climate for innovation in several ways. On the supply side, they help determine the after-tax cost of undertaking an additional unit of R&D through business income tax rates and tax incentives for R&D investment. On the demand side, taxes can alter the incentives for individuals to form their own businesses and the pace at which they grow. In December 2017, Congress passed a law (P.L. 115-97) that made significant changes in the federal tax code, including substantial cuts in business income tax rates. Many of the changes went into effect on January 1, 2018. One question for lawmakers concerns how these changes are likely to affect the domestic climate for investment in innovation in the short run. Answering the question requires a clear understanding of how previous tax law affected that investment. Impact of Previous Tax Law Federal tax law before the enactment of P.L. 115-97 affected the domestic climate for technological innovation in three primary ways. First, it offered incentives to invest in domestic R&D and in new, more advanced machinery and equipment, and software. Second, previous tax law provided an incentive to produce or use domestically new technologies developed anywhere in the world. Third, it influenced the incentives for individuals to form small entrepreneurial companies through income and capital gains taxes. One measure of the incentive effect of these tax provisions is their impact on the marginal effective tax rates (ETRs) for investment in major asset categories. These rates show the share of pre-tax returns that go to pay income taxes. As such, they take into account current income tax rates, as well as tax provisions that help shape a company's tax burden, such as deferrals, deductions, exclusions, preferential tax rates, and credits. Table 1 shows estimates from the Tax Policy Center of the ETRs for major classes of assets (except land) under pre- P.L. 115-97 tax law. The estimates were based on the following assumptions: (1) a corporate tax rate of 35% (now a single rate of 21%) and a passthrough rate of 30% (now a top rate of 29.6%); (2) a required real after-tax rate of return for each asset of 6.5%; (3) an inflation rate of 3%; (4) a nominal interest rate of 6.0%; and (5) a debt financing ratio of 40% for C corporation investments and 30% for non-corporate (or passthrough) business investments. Table I. Marginal Effective Tax Rates for Major Asset Categories by Organizational Form (percent) Passthrough Asset Type Corporations Businesses Equipment 22% 16% Structures 30 22 https://crsreports.congressg