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Executive Summary

The Bush Administration will renew the effort for a permanent R&E tax credit, according to the FY 1990 budget proposals released Feb. 9. Under the President's proposal, a permanent tax credit would be allowed for 20% of research and experimentation (R&E) expenditures over a base amount calculated from the average qualified R&E costs for the 1983-1987 period and indexed to annual growth in GNP. Firms also would have the option of taking a separate credit equal to 7% of R&E expenditures in excess of 75% of the base figure. Deductions for R&E expenditures would be reduced by the full amount of the credit taken. In addition, the new rule's test for determining which companies qualify for the R&E tax credit would be "liberalized to allow new firms and firms entering new lines of business to claim the credit." According to the administration, the new R&E tax credit "would modify the structure of the current credit to increase its incentive effect and availability to firms that undertake research." With the existing rule, firms may receive credit for 20% of R&E expenditures over a base figure determined by averaging the previous three years R&E expenditures. Deductions against taxable income for research costs are reduced by 50% of the credit taken. The present tax credit will expire on Dec. 31, 1989 despite efforts by the Reagan Administration in 1988 to create a permanent tax credit. Characterizing research spending as "essential to fostering technological innovation, which is a major source of growth in productivity," the Bush Administration says it "is committed to encouraging continued growth of private, domestic research activities by establishing a permanent tax credit for research and expirementation." The administration projects that its proposal would reduce overall tax revenues by $ 387 mil. in 1990, $ 688 mil. in 1991, $ 963 mil. in 1992 and $ 1.15 bil in 1993. In addition to the tax credit, President Bush proposed permanent R&E expense allocation rules. Citing the "obstacle to research conducted by American multinational corporations -- specifically the allocation of the deductions for R&E expenses between domestic and foreign income," the new allocation rules are designed to "end the uncertainty and create a climate in which long-term research plans can be made with some assurance that the rules of the game will not change." The Bush Administration is proposing that U.S. multinational companies be allowed to allocate 67% of R&E expenditures to U.S. source income, while the remaining amount would be allocated on the basis of gross sales or gross income. There would be no limitations associated with the gross income method. Previous R&E expense allocation rules, which expired in May 1988, allowed U.S. multinationals to allocate 64% of domestic research expenses to U.S. income. The remaining expenses were allocated on the basis of gross sales or, subject to limitations, gross income. Noting that "U.S. taxpayers generally receive greater foreign tax credit benefits to the extent that their expenses can be allocated to U.S. source income than to foreign source income," the Bush Administration maintains that the new rules "will provide a significant incentive for conducting R&E and for locating that activity within the United States." The new R&E expense allocation rules will reduce overall tax revenues by an estimated $ 1.7 bil. in 1990, $ 749 mil. in 1991, $ 814 mil. in 1992 and $ 887 mil. in 1993. For FY 1989, the Reagan Administration was successful at increasing R&E expense allocations from 30% to 64%.

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