Starting this year, firms must amortize their research and development (R&D) expenses over five years rather than immediately deduct them from taxable income, a policy change designed to raise federal tax revenue in the short term.
As policymakers consider the future of the R&D tax change, one option on the table is to delay the amortization of R&D expenses for four years until 2026, as proposed in the House Build Back Better Act last year. Within the 10-year budget window, a four-year delay would cost about $223 billion less than canceling amortization outright, but it would not increase long-run economic growth.
Canceling R&D amortization outright would reduce federal revenue by about $213 billion between 2022 and 2031, while increasing long-run GDP and American incomes by 0.1 percent.
Delaying the amortization until 2026, on the other hand, would raise about $11.2 billion over 10 years and not increase long-run GDP or American incomes. Other options to delay R&D amortization by one to three years would also slightly raise revenue, but again, without a long-run economic benefit.
|Delay R&D Amortization for 4 Years||-$56.0||-$24.3||-$11.1||-$4.1||$74.0||$24.3||$8.4||$0.0||$0.0||$0.0||$11.2|
|Delay R&D Amortization for 3 Years||-$56.0||-$24.3||-$11.1||$72.6||$23.7||$8.0||$0.0||$0.0||$0.0||$0.0||$12.9|
|Delay R&D Amortization for 2 Years||-$56.0||-$24.3||$61.4||$23.3||$7.7||$0.0||$0.0||$0.0||$0.0||$0.0||$12.1|
|Delay R&D Amortization for 1 Year||-$56.0||$43.8||$14.7||$7.5||$0.0||$0.0||$).0||$0.0||$0.0||$0.0||$10.0|
Source: Tax Foundation General Equilibrium Model, May 2022.
Delaying amortization by four years would slightly raise revenue in the budget widow compared to a $213 billion revenue loss under permanent cancellation largely due to timing shifts. A temporary tax policy, however, would not increase long-run GDP because it would not affect long-run incentives. Temporary tax policy can change the timing of investment decisions, or temporarily increase investment only to have it drop off later, but because temporary tax policy does not change the long-run after-tax return to investment, the long-run size of the economy is not affected.
A temporary delay also creates a risk that R&D expensing becomes an ongoing “tax extender,” creating uncertainty about the tax treatment of R&D as businesses make investment decisions.
While extending the full deduction of R&D expenses until 2026 may be preferable to allowing amortization to go forward in 2022, a superior option for economic growth and the stability of the tax code would be to cancel the upcoming amortization of R&D expenses permanently.
Modeling the Timing of R&D Deductions and Impact on Federal Revenue
Switching from full expensing for R&D costs to five-year amortization temporarily limits the amount of deductions businesses can take, which raises baseline revenue. The higher revenue from the switch is one of the reasons R&D amortization was included in the Tax Cuts and Jobs Act (TCJA). Delaying the switch to amortization delays the higher revenue and has a somewhat counterintuitive interaction with the current law baseline.
Under the delay, between 2022 and 2026, firms would continue taking immediate deductions instead of amortizing them over five years, which reduces business taxable income and tax liability and thus lowers federal revenue. Between 2027 and 2031, firms would begin amortizing deductions, which increases business taxable income and tax liability and thus raises federal revenue.
The following table illustrates the timing difference of the delay against the backdrop of the current law baseline. Imagine a firm making $100 of R&D investment each year. The cost of the investment is fully deductible in 2021.
Under current law, starting in 2022, just one-fifth of the investment, or $20, is deductible each year. As new investment is made each year, one-fifth is deductible, meaning in 2023, firms take a total of $40 of deductions (reflecting one-fifth of 2022 investment plus one-fifth of 2023 investment). The pattern continues until the deductions for the 2022 investment are completed in 2026, at which point the total deductions allowed each year would level off. Total deductions each year would reflect one-fifth of total investment from the current year and the four years prior.
We can compare the deductions allowed each year under the current law baseline to the deductions allowed each year if amortization is delayed for four years until 2026.
Early in the budget window, more deductions would be allowed if amortization is delayed until 2026, which reduces federal revenue. For example, in 2023 deductions would total $40 under current law, but $100 is allowed under the delay. After amortization begins in 2026, the same phase-in of deductions occurs over five years, which increases federal revenue. For example, in 2028, deductions would have already built back up to $100 under current law but would only be $60 under the delay option.
In the long run, however, both options result in the same annual revenue effect—from the perspective of the federal budget, it is simply a short-term shift in the timing of deductions.
|Total annual R&D investment||$100||$100||$100||$100||$100||$100||$100||$100||$100||$100|
|Total annual deductions under current law (5-Year amortization starting in 2022)||$20||$40||$60||$80||$100||$100||$100||$100||$100||$100|
|Total annual deductions when 5-year amortization is delayed until 2026||$100||$100||$100||$100||$20||$40||$60||$80||$100||$100|
|Difference in the value of R&D deductions under amortization delay||$80||$60||$40||$20||-$80||-$60||-$40||-$20||$0||$0|
Note: The nominal value of the R&D investment and deductions are not adjusted for inflation.
Source: Author calculations.