WHILE the United States Senate forges ahead to close tax loopholes for the wealthy, a tax disaster lurks in the background, waiting to spring on companies that depend on research for their future. That disaster is the proposal to base a minimum corporate tax in part on the amount of research and development that companies undertake. The proposal is not, as you might suppose, to reduce taxes for companies investing heavily in their futures. On the contrary, the Senate is considering adding R&D expenses into a base on which a minimum tax would be levied.
The objective of the minimum tax is to force all profitable companies to share in the tax burden. At present, elaborate loopholes allow at least 10 of America's largest corporations to pay little or no taxes on immense profits. US electronics companies are not among the culprits. On the contrary, the industry pays very high effective tax rates -- about double the national average. But the proposed method to force non-taxpaying companies to pay taxes -- taxing them on research and development spending -- would in fact strike hard at high-tech companies that are using innovation to build America's future while still picking up more than their fair share of the nation's tax burden.
The Congressional Budget Office estimates that electronics companies as a whole already pay effective tax rates of more than 30 percent, substantially more than would be required under a proposed 25 percent minimum tax. And this is under the present law, which allows companies to deduct R&D expenditures in the year in which they are incurred.
But legislation now before the Senate would treat R&D spending as taxable capital assets that must be ``amortized'' (spread out) over a five-year period. In effect, a company would be able to deduct only 20 percent of its current-year R&D spending when computing income that's taxible for a minimum tax.
Including R&D as (in tax terminology) a ``preference'' item on which taxing would be based would in fact be a brand new tax upon US high-tech. The bill would amount to a $17 billion increase for American industry over the next five years -- a powerful disincentive for R&D at a time when rising competition from abroad demands that the US invest in more, not less, R&D.
Arguments against basing a minimum tax in part on R&D expenses abound:
Profitmaking companies do not at present escape taxation by investing in research and development. The Securities and Exchange Commission requires companies to ``expense,'' or fully deduct, R&D costs before reporting income to shareholders. Profits are measured after deducting R&D expenditures fully when they are incurred. This SEC requirement prevents companies from inflating financial income for accounting purposes while reducing it for tax purposes.
Nonprofitable firms would be penalized for investing in R&D, because the new requirement could bring them under a minimum tax. The effect on these nonprofitable firms could be devastating.
The penalty for increasing R&D investments would be severe. The higher the R&D investment, the higher the tax. The 10 US companies with the highest ratios of R&D to sales would have had to pay more than 35 percent of their incomes in taxes. Moreover, a minimum tax that requires R&D amortization would have increased taxes paid by R&D spenders in 1984 by more than three times the increase that would have occurred under a minimum tax that allowed R&D expensing.
Taxing R&D puts us behind our international competitors. No other country cuts back on the effect of R&D deductions by means of a minimum tax.
Japan, for example, permits five-year carryovers of unused R&D deductions and also provides a tax credit equal to 20 percent of the excess of current R&D expenditures over the largest amount of R&D expenditures incurred in any single tax year. In addition, it allows a special deduction of up to 40 percent of corporate income for companies that derive income from ``overseas transactions in technical services.'' Japan's growing technological dominance and trade surplus show the results.
Even Britain can show higher productivity than the US, in part because of its long-term approach to R&D; all R&D expenditures are fully deductible in the year they are incurred, and unused deductions may be carried forward for up to five years.
Congress's proposed treatment of R&D simply does not reflect economic reality. Proposals to require amortizing R&D spending for minimum tax purposes are based on the view that R&D creates an economic asset for the innovating company, an asset that depreciates over time.
But look at the facts:
Eighty-eight percent of R&D projects are not economically successful. Clearly they do not represent depreciable assets. Thus, the spending on such projects is appropriately charged to expense.
Any attempt to impose an amortization requirement on ``successful'' projects is in vain, because companies cannot determine in advance which of their R&D projects will succeed economically.
Even a partial amortization requirement would distort economic income, since R&D success rates vary widely among companies and industries.
Regardless of one's views on the minimum tax that is in the concept stage, there can be no question that the novel requirement of taxing R&D costs over a five-year period, rather than letting them be deducted in the year they occur, would seriously penalize America's R&D-intensive companies. Dragging down US innovation could not happen at a worse time for either the nation's economy or its trade balance.
America for a generation has stood upon a foundation of technological preeminence.
We have achieved it only by combining vastly expensive long-term commitments with the unique American willingness to take risks. Greatly increasing the price of such risk for US companies and entrepreneurs, especially for the sake of giving Congress more short-term revenue, is a certain prescription not just for sectoral but for national decline.
Vico E. Henriques is president of the Computer and Business Equipment Manufacturers Association.