R&D Spending Fools? An Analysis of the R&D Credit’s Incentive Effects after the Omnibus Budget Reconciliation Act of 1989

The R&D credit has always been incremental in nature, providing a credit for qualified R&D expenses exceeding some base amount. Originally, the base amount was the average of the previous three years’ R&D expenses (i.e., a moving average). After heavy criticism that the credit's incentive effects were largely offset in the following three years, Congress substituted the moving average base with a fixed-base as part of the Omnibus Budget Reconciliation Act of 1989. This study examines the impact of this structural change on the number of firms that are eligible for the credit and the type of firms that are eligible for the credit. In addition, we examine the incentive effect of the R&D tax credit for firms that qualified for the credit, and whether the incentive effect changed after the implementation of OBRA89. Using data from 1981–1994, we find overall firm eligibility declined after OBRA89, but increased for firms belonging to high-tech industries, relative to firms belonging to other industries. Fixed-effects regressions that control for various non-tax factors indicate that median R&D intensity increased approximately 11.0 (5.4) percent from 1986–1989 to 1990–1994, producing credit induced additional spending by high-tech (other) firms of $3.54 ($1.68) per revenue-dollar forgone. Overall this translates into an estimate of $2.40 of additional R&D spending per revenue dollar forgone.