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Oregon lets R&D tax credit expire – will others follow?

October 26, 2017
By: Mark Skinner

At least three dozen states offer reductions in tax obligations to companies for some portion of the costs of the businesses conducting research and development within their particular state. During the 2017 session, one fewer could be included among the ranks. With little documented opposition, the Oregon legislature decided to get out of the R&D tax credit business altogether (p. 41, source).  Why? Are there lessons for other states’ advocates for innovation?

From SSTI’s research, the Oregon decision appears unprompted by financial necessity. The cost to the state to extend the R&D tax credit couldn’t be a serious issue ($40 million over six years in a state budget surpassing $38 billion annually). It also appears not to have been because of any disagreement on the merits of increasing R&D activity in the state. Yet House Bill 2078 to extend the existing credit through 2024 was allowed to die in committee with the session’s adjournment in July.

While a majority of states offer R&D tax credits, the range in the designs and benefits is extensive and laws vary as to how they affect a company’s tax bills: they can apply to reductions in franchise taxes, sales and use taxes, income taxes, payroll taxes or simply the overall tax obligations. Restrictions can range from particular uses of the R&D funds, such as purchases for machinery, equipment and facilities, particular sectors of strategic importance to the state, R&D activities beyond past performance, or R&D activity with particular partners, including universities and small businesses.  

In Oregon’s case, corporate taxpayers could claim a credit up to $1 million per year for qualifying research expenditures in Oregon above a base amount. Companies had two options for calculating the credit but most often used the simple five percent of the excess amount. Unused balances could be carried forward for up to five years.  The credit first appeared on the Oregon tax books in 1989.

Despite languishing in committee, the tax credit’s demise was not without consideration. A relatively novel feature of state government practice across the country, Oregon’s Legislative Revenue Office (LRO) compiled a Report on Expiring Tax Credits for the state legislature in February 2017.  It is actually a standard document prepared as part of the state’s biennial budget process throughout the past two decades.

The LRO looked at several measures in its assessment of the tax credit’s performance:

  • the fiscal impact of the tax credit on state revenues;
  • the extent of the credit’s use by size of business (by sales) and industry;
  • the share of the credit claimed versus the amount used in a given year;
  • the change in business R&D expenditures in Oregon over time;
  • the structure or attractiveness of the Oregon tax credit compared to 37 other states’ offerings;
  • theoretical rationale for the potential benefits or motivating influence of an R&D tax credit; and,
  • empirical evaluations of the merits of tax credit implementation in other states and countries.

The LRO concluded several things based on its analysis: the Oregon tax credit fell in the middle of the pack among states; it cost very little to administer and was simple for businesses to use; the vast majority of the credit’s use was among Oregon’s very smallest and very largest businesses based on taxable income; and most (74 percent) of the credits claimed were not used in the years earned.  The agency also noted, however, that R&D expenditures by Oregon businesses nearly doubled during the previous ten years (using most recent data). Oregon industrial R&D spending in 2013 equaled 2.9 percent of state GDP and was $1,435 per capita. Compared to other states, Oregon ranked 8th and 9th respectively for those metrics.

The Oregon R&D tax credit may have died because it lacked the underlying need for a public policy intervention. Tax credits are supposed to entice some publicly desired change in behavior for the parties receiving the credits. If the policy does not have the desired effect, the legislature should reconsider it, modify it or eliminate it. 

If Oregon’s goal was to increase industrial R&D activity in the state, the desired end goal was happening anyway and strongly. The LRO analysis suggests there was no market failure for the public sector to address.  The report also reveals there is a mismatch in the program’s fiscal benefit and the likelihood of influencing business behavior. With Oregon’s corporate R&D expenditures surpassing $5.6 billion in 2013, the $15.2 million in tax credits used were not likely a significant influence on whether or not the R&D took place in state: other factors matter much more.

Resource Tip: The Oregon Legislature Revenue Office Tax Credit Review: 2017 Session includes several useful elements for other state policymakers and proponents for strengthening their own innovation capacity. In addition to the references to individual states’ analyses of their own tax policies, Appendix B includes a breakdown of all research-related tax credits offered by 37 other states across the country. The structure of the discussion of the Oregon R&D tax credit (pages 15-22) also may serve as a starting point for conducting other analyses of the merits and efficacy of your own states’ innovation-related tax policy tools. 

Oregonr&d tax credits