The Consequences of Limiting the Tax Deductibility of R&D

Abstract

We study the effects of limiting the tax deductibility of research and development (“R&D”) expenditures. From 2022 through 2024, U.S. companies were required to capitalize and amortize R&D rather than immediately deduct these expenditures. We use variation in U.S. firms’ fiscal year ends to examine the extent of—and heterogeneity in—firms’ responses to the R&D tax change in a difference-in-differences framework. We first document that affected U.S. firms’ cash effective tax rates increase by 9.6 to 10.9 percentage points (47.5% to 56.8%). Second, we find that R&D investment declines in response to the change; we estimate an aggregate reduction of $42 billion in the first year of the policy. This reduction is concentrated among research-intensive, domestic-only, and financially constrained firms. Third, we estimate decreases in domestic R&D employment of 1.4% to 2.6%, relative to domestic non-R&D employment. Finally, we observe decreased capital expenditures and share repurchases among affected companies, consistent with the R&D tax change impacting firms’ other investing and financing decisions. This paper provides policy-relevant evidence regarding the significant real effects of limiting the R&D tax deduction, which is an important but understudied innovation tax incentive.

Keywords: R&D, Tax, Incentives

JEL Classification: H25, M41, M48