The head negotiators for tax policy in the House and Senate reached an agreement on an $80 billion tax package, which included key provisions to fix how the U.S. treats research and development (R&D) investments. Specifically, the bill extends full deduction for domestic R&D expenses through 2025. The bill also prolongs the window for immediate expensing (also known as bonus depreciation) for machinery and equipment through 2026. For large and small businesses, research and development is critical to job creation, economic growth, and environmental progress. To provide business certainty and encourage more innovation, it would be in America’s economic and environmental interest for policymakers to make full expensing permanent.
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For roughly 70 years, businesses could deduct expenses in basic and applied research and development in the year they were incurred. The provision covered everything from the scientists and entrepreneurs conducting the research to the cost of equipment and facilities. It also included domestic and foreign R&D investments. That provision lapsed in 2022, meaning companies would have to amortize the expenses over several years.
It works like this: In a world with immediate expensing, if a company has $2 million in income, but $1 million in R&D expenses, the firm’s taxable income would be $1 million (after fully deducting the $1 million). Under the new provisions, the company could only deduct $100,000 in the first year, making the taxable income for the year $1.9 million.
In effect, the change was an unexpected tax hike – one that hits manufacturers and small businesses particularly hard. Miltec UV, for instance, is a Maryland-based manufacturer that uses an eco-friendly curing technology to dry coatings and adhesives. Last fall, Miltec UV CEO Bob Blandford remarked, “Absent congressional action, we’re gonna get hit hard. Our taxes are going to go up dramatically. That’s cash getting sucked out of the business. So that’s going to get pretty ugly.”
As the National Association for Manufacturers points out, the U.S. is now only one of two developed countries in the world to require amortization of R&D expenses. And the policy lapse puts the U.S. at an even further disadvantage for how China treats R&D expensing. Chinese policy provides a super deduction, allowing for an additional 100 percent to be immediately expensed.
If not addressed, the change in tax policy will have profoundly harmful impacts on research discoveries, innovative breakthroughs, and economic growth. Critically, amortization would slow the growth of cleaner technologies, whether that is R&D investment in small modular reactors, battery storage, or more energy efficient manufacturing processes. For smaller American companies and start-ups, amortization could threaten their financial viability.
In fact, the policy change has already created a notable decrease in R&D investment. A recent Chamber of Commerce analysis found that “rate of growth of R&D spending has declined from 6.6% on average over the previous five years to less than 1% over the last 12 months—notably decreasing by 1.2% in the most recent quarter.” Without a fix, the R&D Coalition projects the U.S. economy would see a drop in R&D spending by more than $4 billion annually in the first five years and $10 billion annually over the second five. Within a decade, more than 50,000 jobs would be lost.
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Fortunately, Congress has introduced a fix. House Ways and Means Committee Chairman Jason Smith (R-MO) and Senate Finance Committee Chairman Ron Wyden (D-OR) released a bipartisan plan that would restore immediate expensing of R&D. The framework would also allow for full and immediate expensing of machinery, equipment, and vehicles, which would incentivize investments in cleaner, more efficient technologies.
Immediate expensing may not be what comes to mind when one thinks of climate policy, but it should be. It is a pro-growth, technology-neutral policy that spurs innovation, new discoveries, and human progress. That, in turn, will lead to the wide scale deployment of affordable clean energy sources and incentivize investment in energy efficient technologies and processes. This new bill is a step in the right direction, though it still falls short by not making immediate expensing a permanent fixture in the tax code. Expensing is a truly win-win policy and the longer it remains lapsed, the more the American economy, U.S. competitiveness, and the environment suffer.
