Turning Corporate Taxes into an Innovation Spur

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In particular, innovation economics holds that market forces alone often do not produce optimal outcomes and that public policy, including tax policy, that corrects these mismatches can enhance societal welfare.

As such, a corporate tax code based on innovation economics would seek to explicitly promote the international competitiveness of American businesses and encourage innovation by lowering the effective rate, but doing it in ways that also provide strong innovation incentives. There are three things Congress should do:

First, Congress needs to spur R&D spending by altering the tax code. Lawmakers should expand the R&D tax credit by increasing the Alternative Simplified Credit rate from 14% to between 20% and 40%, depending on how much investments are increased. In addition, it's time to broaden the definition of qualified R&D from beyond that involved in inventing a product to that involved in developing a production process. Congress should also broaden the current flat credit for collaborative energy-related research to any area of research and expand the rate to 40% from 20%. Taking these steps would make the U.S. R&D tax credit among the five most generous in the world.

Encouraging Employee Training

Second, investment in new capital equipment—machinery, computers, and software—is needed because it is through such purchases that innovation spreads. One way to do this would be to let firms write off investments in capital equipment in their first year instead of having to depreciate investments over a number of years.

Third, for business to get the full benefits from new equipment, they need higher-skilled workers. Providing a carrot for on-the-job education, Congress should allow employee-training expenditures to be counted as qualified expenditures for the Alternative Simplified R&D Credit.

Even if conventional economists can be persuaded that these activities are subject to market failures that tax code can help correct, many may still resist, arguing that the nation can't afford new incentives and that more innovation would be spurred if we instead paid down the national debt. The short answer is that it's more effective to target these kinds of innovation-enhancing activities than to simply reduce the debt in the hope that interest rates fall.

U.S. Is at Risk

But it is possible to have more innovation tax breaks and lower deficits. Congress could repeal the portion of the 2003 Jobs and Growth Tax Reform & Reconciliation Act which reduced the top individual tax rates on dividend income to 15% for investors in the top four tax brackets and 5% for investors in the bottom two tax brackets. In addition, Congress could raise top marginal rates back to the Clinton era rates or even slightly higher.

One way not to pay for these is to limit deferral of foreign source income, as the Obama Administration has proposed. Such a move would raise less revenue than expected, and by raising corporate taxes, move us in exactly the opposite direction we should go in.

In short, the U.S. is at risk of losing its global competitive advantage and with it faster per-capita income growth. To effectively respond will require the nation to take concerted and strategic actions in a host of areas, including reform of the corporate tax code to transform it into an energetic tool to support private sector efforts to innovate and be more productive.

Rob Atkinson is Founder and President of The Information Technology and Innovation Foundation, a Washington, DC-based think tank.  He is also author of The Past and Future of America's Economy: Long Waves of Innovation that Drive Cycles of Growth.  His focus is on IT and innovation and policy to support them.

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