HD46 - A Joint Study of Research and Development Tax Incentives

Executive Summary:

Purpose of Study

Use of state-level income tax and sales tax incentives to promote research and development (R&D) activities within Virginia, as witnessed by current state law, is accepted state policy and practice. HB 1667 and HJR 700 collectively direct investigation of what other states are doing in the way of such incentives and whether the Commonwealth could effectively do more to encourage R&D.

Study Approach and Findings

The multi-agency study group undertook a broad reconnaissance of current state and federal level R&D tax incentives, as well as available reports and statistical information, to assist in analyzing the nature, extent, and effective impacts of such incentives. In terms of the Commonwealth’s R&D performance compared to its sister states, the results of this analysis present a less-than-glowing picture. While the state is 12th nationally in population, Virginia ranks anywhere from 14th to 21st by most statistical measures of R&D conducted in the state.

Twenty-one states currently provide R&D tax credits. In terms of the actual effectiveness of these state-level tax incentives in bringing in R&D dollars, though, there appears to be little more than anecdotal evidence. At the federal level, a somewhat greater level of relevant data does exist. One analysis of eight different studies of federal research tax credits, for example, found the results were mostly positive but taken as a whole, not strongly conclusive. Few policymakers or practitioners argue, however, that a comprehensive state policy towards promoting high-tech growth could exist and be well perceived without a meaningful R&D tax incentive component. And federal studies do suggest that corporate R&D spending is sensitive to incentives.

As the economy of the nation and Virginia in particular becomes increasingly technology-oriented—and, therefore, increasingly dependent on technological innovation—the study group feels that R&D tax incentives may be a significant tool in increasing the state’s competitive position in the global economy. The study group determined that Virginia could learn much from the nationwide experience to date in strengthening its current R&D tax incentive program. Incentives can be directed where there is the greatest likelihood of paybacks. And the identified, inherent weaknesses in current federal and many other states’ incentives do not have to be repeated in future Virginia initiatives.

Recommended Goals for R&D Tax Incentives

• To ensure that future state initiatives are well focused and take advantage of lessons learned to date, the study group recommends that Virginia’s R&D tax incentives support the following goals:
Avoid creating incentive programs which reward taxpayers for conducting R&D activities that they would in all likelihood conduct in the absence of any such incentive.

• Create incentive programs that have the minimum amount of negative impact on the natural action of market forces.

• Create incentive programs that will assist small, research intensive start-ups where, dollar-for-dollar, more marketable products may result from applying such incentives.

• Create incentive programs that will encourage private companies to sponsor more research at Virginia’s universities.

• Structure incentives that avoid the type of complexity that is present in federal research tax programs.

Legislative Recommendations

Consistent with the study findings and the above-noted goals, the study group recommends the following legislation, should the General Assembly consider the results to be fiscally worthwhile:

• Research and Development Tax Credit—Consider extending the provisions of the Equity and Subordinated Debt Investors Tax Credit Act (Section 58.1-339.4, Code of Virginia) to companies with gross receipts of less than $5 million. Allow the credits to be sold back to the Commonwealth at 70 cents on the dollar when the company does not have sufficient Virginia tax liability to use the entire credit to which entitled in any taxable year. House Bill No. 1667's investment tax credit for R&D expenditures should be appropriately revised to reconcile that initiative with this proposal and avoid any use of the same expenditure to claim multiple credits by technology start-ups.

• Research Sponsored at Virginia Universities Tax Credit—Consider allowing firms an annual tax credit of 40% of the total amount of funds spent to sponsor qualified research activities at Virginia’s public or private universities. House Bill No. 1667's investment tax credit for R&D expenditures should be appropriately revised to reconcile that initiative with this proposal and avoid any use of the same expenditure to claim multiple credits by technology start-ups.

As per the requirements of HJR 700, the study group also evaluated Florida’s program of tax incentives targeted to specific high technology manufacturers. In general, the study group favored more generally applied incentives, such as those recommended for consideration above, over those aimed at specific industries. In addition, the industry-specific sales and use tax exemptions included in the Florida legislation have long been available to all firms operating in Virginia.