Mike Konczal has drawn my attention to a Austan Goolsbee’s 1997 paper [PDF] on “Investment Tax Incentives, Prices, and the Supply of Capital Goods.” Mike’s central point, as I understand is, is that Goolsbee’s findings suggest that the Obama administration’s proposal to make the R&D tax credit permanent is unwise:
So Goolsbee spent most of his early academic career proving, using detailed statistics and carefully cultivated data, that using R&D style tax policy to smooth business cycles and stimulate investment is a really bad idea. (Again, Goolsbee: ” For policy makers interested in using tax policy to stimulate investment or, especially, to smooth business cycle fluctuations, the results are not promising.”) Let’s watch him defend it in the public sphere because the term “stimulus” has become toxic amid high unemployment and because this is all that can get through the broken Senate. Poor academic.
All things considered if this is all that can move I suppose I should support it. But it’s terrible bang-for-the-buck style stimulus if it is even that, and supporting rent structures inside R&D pipelines is hardly the investment that energy-retrofitting homes or building rail would be for the 21st century economy.
Leaving aside Mike’s proposed alternatives (I like the idea of public investment in rail, but I fear that most rail enthusiasts are embracing a wrongheaded approach), I’m not sure he’s being entirely fair to the White House. My sense, and I could be wrong about this, is that the permanent extension of the research and development tax credit is aimed at enhancing long-term prospects for growth. In his 1997 paper, Goolsbee writes:
Investment demand is actually very responsive to investment tax policy but in the short run the increaseddemand for investment mainly increases capital goods prices rather than quantities. A large part of the subsidy’s reduction of the effective purchase price of equipment is simply lost to the capitalsuppliers.
This argument was raised at least as far back as the 1969 debate in the Joint EconomicCommittee over the ITC where representative Henry Reuss of Wisconsin asked the Secretary ofthe Treasury if he “had truly considered the impact of the 7-percent investment tax credit which,in addition to costing the treasury some $3 billion a year in revenues, produces an inflationaryoverheating of the capital equipment market.” The results presented below will demonstrate that the content of Rep. Reuss’s comment actually has quite important implications for the study of investment.
But as Goolsbee explains, capital goods producers can’t just suddenly ramp up production:
For evidence, I use data on the prices of capital equipment goods compiled by theBureau of Economic Analysis (BEA) and link them to the corresponding tax price for each assettype. The results suggest that capital goods prices rise significantly in response to changes in taxsubsidies. Reduced form estimates indicate that a 10 percent tax credit increases the price by 3.5 percent to 7 percent overall, and close to 10 percent for several types of assets. The results are highly robust. Additional results show that the price increases are largest where there are capacity constraints or low imports and that the wages of production workers in capital goods industries rise with the subsidies, as well. Actual estimates of the supply elasticity center around 1 and imply that the true elasticity of investment demand exceeds 1 in absolute value. [Emphasis added.]
One possible inference is that while investment tax incentives don’t work well in the short-run, they might work reasonably well in the long-run, as capital goods producers expand capacity or new entrants are given an opportunity to compete. But as Goolsbee notes, “policymakers in the United States repeatedly change investment tax policy,” and so “short-run asset price effects are of first order importance.”
This seems like as decent an argument as any. But I imagine Goolsbee will find it easier to defend a permanent extension of the research and development credit than his critics suggest.
There is another reason to oppose the research and development tax credit, namely that the fetish for research and development expenditures is misplaced. My colleagues at Economics 21 recently published an editorial on the extension that offers a decidedly lukewarm endorsement:
While the Obama Administration’s proposal is certainly better than keeping alive this annual “tax extenders” charade, it seems that the benefits of permanent extension are being seriously oversold. Economists tend to favor subsidies to encourage corporations to invest in fundamental research and experimentation in the belief that innovation is the essential driver of productivity growth. But it’s not at all clear how effective the credit is at stimulating incremental research expenditures, with some research suggesting a 10% increase in the credit induces increases in research spending of between 2% to 5% (see page 159 of the JCT document – previous link).
Some, like economist Amar Bhide in his book The Venturesome Economy, have argued that an emphasis on traditional R&D spending is misplaced. “High-level” inventions drawn from R&D in the United States have been successfully exploited by for-profit firms in East Asia and Europe, and the reverse is also true. It is the commercialization, diffusion, and consumer embrace of new ideas and inventions that creates value for economies, not “high-level” inventions per se.
The editorial continues:
According to JCT, 81% of the tax benefits from the R&D tax credit go to businesses with more than $50 million in assets.This is due partly to the accounting and back office investments necessary to comply with the credit’s copious documentation requirements. The U.S. already spends 25% more on R&D as a share of its economy than the average rich country, making talk of “falling behind” discordant with the facts. Somewhat ironically, the only country that spends substantially more on R&D is Japan, whose economy has been virtually stagnant since 1991.
It’s not clear that this measure is worth the revenue loss.
