As the United States Senate debates a tax deal that would restore neutral tax treatment for most research and development (R&D) expenses, the People’s Republic of China (PRC) has adopted an aggressive policy to subsidize R&D investment. This puts the U.S. at a disadvantage if it does not fix its own R&D tax system.
Currently, U.S. companies are not able to deduct the full value of their R&D investments due to a provision of the Tax Cuts and Jobs Act. Instead, they are required to amortize (spread deductions out) over the course of five years for domestic R&D and 15 years for foreign R&D. This means U.S. firms are only able to deduct roughly 89 percent of their R&D costs in real terms—and even less if inflation is above 2 percent.
On the other hand, China has pursued a policy known as a super deduction, which allows companies to deduct more than 100 percent of their R&D costs. In 2023, the Chinese expanded their super deduction from 175 percent of R&D costs to 200 percent of R&D costs for most businesses. This amounts to a large subsidy.
Despite the heavy subsidies, China has not overtaken the United States in terms of R&D investment. However, China has reduced the gap with the U.S. in recent decades. In 2019, the U.S. spent $668 billion on R&D, which accounted for 3.1 percent of GDP. The same year, China spent $526 billion in R&D, or 2.2 percent of its GDP.
The U.S. should not necessarily emulate China’s super deduction policy. One risk with such a generous subsidy for R&D is a shift in expense classification. Firms might also reclassify non-R&D expenses as R&D to juice the amount of expenses eligible for the subsidy. Alternatively, the subsidy could end up simply boosting the salaries of already-employed researchers, rather than increasing real research activity.
Nonetheless, penalizing R&D when China has moved to subsidize it so aggressively is a real concern. In 2023, private investment in R&D only grew by 0.8 percent, while overall business investment grew by 4.4 percent—the slowest annual growth in R&D investment since 2012.
The tax deal’s approach to R&D amortization is incomplete, as it reinstates R&D expensing for only two years and for only domestic R&D. Ideally, the tax deal would restore full expensing for U.S. companies’ foreign R&D investment as well. It’s in the interest of U.S. workers for U.S. firms to succeed on the world stage—ultimately, both types of R&D investment are complementary and it makes little sense to penalize outbound R&D investment in the U.S. tax code.
Though providing permanent R&D expensing alone would not be a China-competition magic bullet, it is a no-brainer place to start. In this technological race, we should first make sure we have not tied our own shoes together.
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