South SFV Today

A provision within the 2017 Tax Cuts and Jobs Act has been identified as a factor hindering innovation in the United States. The section, titled "amortization of research and experimental expenditures," altered how companies are taxed for their research and development (R&D) spending. Previously, firms could deduct 100% of R&D expenses annually, but post-amendment, this deduction is spread over five years, increasing R&D costs.

Rebecca Lester, an associate professor at Stanford Graduate School of Business, explains that Congress included this change to balance the $1.3 trillion cost of the tax package on paper. "They kicked the effective date to 2022, much later than other pieces of the bill, with the idea that they would come back and fix it later." However, political obstacles prevented its repeal.

Research by Lester alongside Mary Cowx from Arizona State University and Michelle Nessa from Michigan State University reveals a $12 billion decline in R&D investment among highly research-intensive companies after the rule's implementation in 2022. "And that's a fraction of the total impact," Lester states.

The amendment initially affected companies whose fiscal year ended in December 2022. This timing provided researchers with a natural experiment to analyze its effects compared to those firms whose fiscal years ended later.

Domestic companies bore significant impacts since U.S. multinationals conducting R&D abroad were less affected. Financially constrained firms and those in sectors like pharmaceuticals and technology faced substantial challenges due to reduced deductions.

"You would normally expect the U.S. to enact policies designed to increase investment in research and innovation," says Lester. Yet there was an observed 11% drop in R&D investment among leading research firms. To manage increased tax costs, some companies also cut capital expenditures and share repurchases.

Lester notes that these findings represent a subset concluding their fiscal year at 2022's end; as more companies were impacted throughout 2023, the reduction likely grew larger.

Corporate leaders anticipated Congress would repeal this amendment by 2022 or even 2023; thus many attempted to absorb increased costs temporarily. The significant cuts made indicate the new tax burden's weight.

The study also investigated whether reduced R&D spending hindered innovative projects more than incremental ones but found no evidence supporting such discipline through policy measures.

In January 2024, legislation aimed at repealing this amendment passed in the House but was rejected by the Senate in July. There remains hope for reconsideration post-2025 elections.

For now, Lester suggests reclassifying expenses as one potential short-term solution for companies wishing to maintain R&D investments while awaiting legislative action from Washington D.C., stating: "We've created an incentive structure that disadvantages domestic innovation."

This report originally appeared courtesy of Stanford Graduate School of Business.