Against the Research and Development Tax Credit

Let's eliminate the corporate income tax and replace it with a VAT to make up for loss revenues.

The corporate income tax distorts incentives while the VAT tends to be neutral.

Corporations don't in fact pay the corporate income tax; they are only pieces of paper filed in the secretary of state's office. People pay it - shareholders, employees, or customers. It probably varies in every case depending on the circumstances of the industry and the particular company. Harberger thought that in a modern economy with import competition the burden fell mostly on labor.

One can't say much for the equity or efficiency of tax that nobody can be sure who is paying it. But this is its political virtue - it hides the cost of government from those who pay it.

The R&D tax credit originated at the time of the Reagan business tax cuts. It was a way of spreading some of the benefit of tax reduction to high tech companies who got little benefit from depreciation acceleration, because they had very short lived assets. It was a way to get Democrats on board, who can only tolerate tax reductions when they seem to amount to "industrial policy"- manipulating businesses in the direction of some command and control end.

One might ask what is the benefit of tax reduction to corporations when they don't really pay the tax in the end. I think this is a matter of cash flow. Government takes away a portion of money coming in the door that might otherwise be invested. This eventually means some combination of lower returns to shareholders, lower compensation to employees, and higher prices to customers. All in all, a deadweight loss.

Ideally it should be repealed, but there is so much economic ignorance in public opinion (encouraged by demagogic manipulation), and there are so many advantages to statists to raise money in this manner, that there is little hope for reform.

I agree with Thucydides on the political economy of the corporate income tax. Unfortunately, this targeted corporate income tax cut misses many firms that are labor intensive and that conduct no R&D, such as firms supplying in-home care givers, security guards, janitorial services, and the like.

Though before making this declaration, we should check that research isn't already tax deductible. Companies would still prefer the credit, because it reduces their remaining tax burden.

As a tax practitioner, I'm skeptical of the R&D credit based on what I've seen. Clients don't increase their research budgets to get more credits. They increase their tax professional budgets to hire people like me (and especially dedicated R&D study firms) to harvest the credits for stuff they already do.

Targeted credits like R&D benefit aggressive taxpayers willing to take their chances on audit, those who can lobby to get subsidies for stuff they already do, those who are willing to pay consultants to harvest the credits, and especially the consultants and lobbyists.

It can't make sense to hand out R&D subsidies and then depend on an IRS agent or a state revenue examiner to determine whether something is really "qualified research."

I would not like to completely get rid of the corporate tax. As long as corporations have limited liability they should pay so tax as a sort of insurance premium that pays for limited liability. In corporations that compete with partnerships the corporation does in fact pay some part of the tax. I think that if we had loser pays in courts perhaps more corporations would become partnerships.

Floccina,

The first problem with your argument is that corporations are a legal construct for a group of shareholders. A corporation is not some nefarious monster but a collection of real, living shareholders.

Secondly, partnerships are also typically limited-liability (they're stupid if they're not unless they're really, really small). A lot of small business do take out loans with a personal guarantee, but they get a smaller interest rate in exchange. The insurance you speak of has nothing to do withthe corporate tax and everything to do with the higher interest corporations pay.

I haven't heard a good argument against eliminating he corporate and capital gains taxes, while instead rolling dividend income into income taxes. Since future after-tax
cash flows are what matters for investors and are factored into the price.

I disagree. We need an incentive to keep R&D in the US. It is too easy to move R&D offshore these days, and the ultimate cost of that is way too high. I have been reading about the R&D tax credit at http://www.technologytax.com. The requirements seem quite onerous, and the IRS auditors quite aggressive. I think we need to make it easier for taxpayers to qualify for the credit -- in addition to making the credit permanent.