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Executive Summary

Congressional budget outlays for research and experimentation could serve as an alternative to tax credits as a way to subsidize R&E expenditures, the Congressional Budget Office suggests in a recently released study of the corporate tax structure. Commenting on the Treasury Dept.'s R&E proposals, CBO said that "the Treasury tax plan would continue the expensing of R&E expenditures indefinitely and extend the incremental tax credit for three years. An alternative would be to subsidize R&E through the outlay side of the budget instead of through the tax system." CBO said that granting R&E subsidies could lead to more programs resulting in benefits to society. "In this way, the Congress could better target funds to R&E projects that offered particular social value, although such a program might tend to reward grantsmanship rather than scientific originality or skill." Under current tax law, expenditures on wages, supplies, and other costs associated with R&E can be expensed. The tax law also provides a credit for R&E expenditures that exceed the average of the three previous years. The tax credit is scheduled to expire at the end of this year. Congressional bills seek to make the tax credit permanent, and extend it to university basic research. CBO notes that the present subsidy for R&E would be eliminated if R&E expenditures were capitalized in a broad-based income tax, in accordance with the economic definition of income. "If the Congress wanted to preserve an R&E incentive, it could do so by maintaining the current tax treatment or by retaining only the expensing provision without the incremental credit," the study says. In an aside, CBO observes that "if tax rates on other investments were raised in moving toward a broader-based tax, the expensing provision alone might prove to be a sufficiently powerful incentive for R&E." The report assesses the reasons behind the R&E tax subsidy. "Since many technological advances provide significant societal benefits, the pure private profit motive may not be sufficient to generate 'enough' economywide investment in R&E," CBO suggests. "There is a wide agreement among economists that some subsidy for R&E is justified; the more difficult problem is determining the appropriate level." The study notes the difficulty in assessing the market value of assets resulting from R&E expenditures. "One possible rule would require firms to capitalize all R&E expenditures, regardless of the true market value of the assets they produce, on the theory that in the long run these expenditures must produce assets worth at least as much as their cost or else they would not be undertaken," CBO indicates. "Under this rationale, no income or loss deduction would be allowed in the year of expenditure, whatever the outcome, and the capitalized expenditures would be amortized over time," the study observes. "This would have to be done according to some arbitrary rule of thumb, such as five years, because there is no way of measuring actual depreciation." The study also undertakes an economic evaluation of the corporate tax, looks at current investment tax incentives, and discusses new directions in corporate tax policy. Copies of the study -- "Revising the Corporate Income Tax" -- may be obtained from CBO, Second and D Streets, SW, Washington, D.C. 20515.

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