Are U.S. tax incentives for corporate R&D likely to motivate American firms to perform research abroad?

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Research and development

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Are U.S. tax incentives for corporate R&D likely to motivate American firms to perform research abroad?

Current U.S. tax policy toward research and development (R&D) is based on the notion that the United States is the dominant competitor in the world for technology-intensive products. (1) While there is some truth to this notion, U.S. technological dominance is eroding at a rapid pace. Table 1 demonstrates that the U.S. share of global sales of technology-intensive products has declined steadily as compared with the major trading partners. Table 2 shows that since the early 1980s the U.S. has spent a constant share of gross domestic product (GDP) on R&D, whereas Japan has increased the proportion of GDP spent on R&D.

At the same time, U.S. firms have increased investments in overseas non-defense R&D at a much faster pace than investments in domestic R&D. Overseas R&D performed by U.S. firms now accounts for well more than 10 percent of total R&D performed by U.S. firms. (2) In addition, data from the Bureau of Economic Analysis (BEA) relating to operations of foreign affiliates of U.S. companies reveal that foreign affiliates of U.S. multinational firms are accounting for an increasing proportion of R&D performed by U.S. firms globally. (3)

More recently, Japan revised its tax-based incentives for R&D investments, and countries such as the United Kingdom, India, and Canada have enacted generous tax and non-tax incentives to attract additional R&D investments. To be sure, R&D investments are expected to follow growth in foreign production, but rapidly increasing R&D costs, declining product life cycles, and inter-country differences in the cost of performing R&D may also influence where firms perform R&D. A key question for U.S. tax policymakers is whether the level of tax incentives for the performance of R&D in the United States is competitive with incentives offered by foreign counterparts.

This article investigates whether the level of tax-based incentives influences where U.S. firms perform R&D investments. It compares annual percentage increases in R&D performed by foreign affiliates of U.S. multinationals in 12 countries for 7 industrial groups over the 1990-2000 period. The data are based on private-sector financed R&D investments (non-governmental sources) by U.S. affiliates as reported by the BEA. The reported results indicate that when compared with the companion industry in the United States, the growth rate in R&D performed by U.S. foreign affiliates was higher in countries with tax-based R&D incentives than in countries without tax-based incentives. Moreover, non-financial foreign affiliates of U.S. firms in Japan, Mexico, and Ireland had annual increases in R&D at rates higher than the remaining countries. When compared with each of the 12 countries on a relative basis, the growth rate in R&D performed by foreign affiliates of U.S. firms in Japan, Mexico, Ireland, and Brazil were also higher than the growth rate of R&D investments by foreign affiliates of U.S. firms in the remaining 8 countries, including investments in the United States.

These results have implications for U.S. tax policy regarding attracting R&D investments of foreign affiliates of U.S. firms to the United States and for keeping existing R&D investments of U.S. interests in the United States. The location of R&D facilities in the United States has important benefits for the American economy. Firms performing R&D hire technical personnel and generate manufacturing jobs that produce employment tax receipts and other favorable economic consequences. Moreover, the location of R&D facilities in the United States is conducive to keeping technology ownership in the United States rather than in foreign countries that may offer more generous levels of R&D-related t...

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