Boeing employees work at the company’s factory in Everett, Washington. (Stephen Brashear/Getty Images)
America’s military edge relies on research and development efforts both inside and outside government. In this new op ed, Eric Fanning — former Army secretary and current head of the Aerospace Industries Association, a leading trade group for the defense and aerospace sector — raises concerns about a new tax rule that he says could threaten R&D investment in the private sector and, by extension, US national security.
At a time when US defense leaders are tackling Russia’s current invasion of Ukraine, while stressing the need to invest in order to stay ahead of the growing competitive threat from China, policymakers have handcuffed innovation with a new tax policy that threatens to stifle vitally needed research and development (R&D) funding.
Maintaining America’s competitive edge has never been more essential, and the headwinds have never been stronger, especially when it comes to US national security. These points will likely be themes of the upcoming National Defense Strategy (NDS), and for good reason. China’s R&D spending in 2020 totaled $378 billion, or 2.4 percent of its gross domestic product, which is a record high. This massive surge in spending has enormous implications for the future of America’s national defense, our economy, and our global leadership. Meanwhile, economic challenges here at home are stressing both our military and the defense industrial base that supports it.
Inflation and COVID’s ongoing economic effects continue to add pressure to budgets, squeezing out long-term investment in things like research to address short-term threats. Russia’s aggressive escalation and advance on Ukraine further complicates US security. The complexity of the situation should compel America’s public and private sectors to work together on the hallmark of the national security partnership that serves our nation so well: unleashing the next generation of game-changing technologies.
Incentives are the key to innovation and have been instrumental to America’s technological superiority for generations. Many of these incentives are built into America’s tax system, which has proven to be an influential tool in spurring innovation and economic growth. Harnessing the power of the free market and our private sector has served as potent catalysts for the invention and introduction of cutting-edge technologies for many years. Today, 71 percent of R&D spending originates in the private sector.
However, a tax law change that went into effect on January 1 is now a major disincentive to private investment in research and development.
Since the 1950s, businesses have been able to deduct qualifying US R&D expenditures for federal tax purposes in the year they were incurred. Leveraging private capital for the public good was a win-win: removing some risks by incorporating incentives into the US tax system fosters industry investment. In January, these incentives dramatically changed. Now companies of all sizes — including eligible startups — must spread or amortize these costs over five years.
For example, US companies investing $100 in R&D are now only able to deduct up to $20 per year over the five-year amortization period resulting in a significant loss in cash flow. Less cash means fewer dollars for research and development and the highly skilled jobs that support it. The US is now one of only two developed countries with this policy (the other is Belgium).
Meanwhile, the Chinese government is doubling down on incentives for innovation, which it believes to be the cornerstone of its future growth and international position. As such, it has designed a strategic incentive regime with the goal of fast-tracking indigenous technological advancement and propelling its economy even further. China has extended its super deduction for R&D expenses for manufacturing companies to an extra 100 percent of eligible R&D expenses in addition to actual expenses incurred. In contrast to US companies, that means for every $100 spent to innovate, Chinese companies can deduct $200, ten times more than American ones can.
History shows us that innovation, and the competitive advantage it provides, requires sustained investment. For many years, America accounted for the vast majority of global R&D spending. In 1960, the US led with 69 percent of global R&D spending, with defense-related R&D accounting for 36 percent of the worldwide total. According to the Congressional Research Service, there has been a marked decline in the US share of that total from 69 to just 30 percent for several reasons, including massive R&D spending by other nations and competitors. China’s share of global R&D rose nearly 488 percent from 4.9 percent in 2000 to 23.9 percent in 2019.
Tax Day is almost here — the enormous gap in incentives that could result from the amortization change must be addressed by Congress immediately. Already, there is strong bipartisan, bicameral support to address the new R&D tax rules, with lawmakers proposing a four-year extension of the previous law. This delay provides companies the certainty they need to take risks on investing in innovation, while also allowing Congress the time it needs to realign the R&D incentives in the long-term. The encouraging news is there are legislative options available in which to address the issue being debated in the coming weeks, efforts which we fully support.
The private sector has played a leading role in advancing the technology we need to maintain our competitive edge, notably in the defense sector. So why wouldn’t we use every tool at our disposal to emphasize and encourage research and development like China does? Why not rely on the power of America’s unique public private national security partnership to accelerate innovation at a time when our economy and the supply chain are recovering from the COVID-19 pandemic?
Our ability to compete globally in high-technology fields, with China in particular, is at stake.
Eric Fanning, a member of the Breaking Defense Board of Contributors, is president and CEO of the Aerospace Industries Association, representing more than 300 companies in the aerospace and defense sector. He served as 22nd Secretary of the Army and Acting Secretary of the Air Force.
