State Waves Goodbye to R&D Tax Incentive

By Kris Johnson, President of the Association of Washington Business

Originally published in the Wenatchee World, November 1, 2014.

Beginning in January, Washington state will become one of just a handful of states in the country that doesn’t offer private employers some kind of a tax incentive to promote research and development activities.

That’s because a pair of tax incentives created back 1994 are set to expire at the end of this year, despite attempts during the last legislative session to extend them.

This may come as a surprise given our state’s growing reputation as a high-tech hub. So much of Washington’s economic growth during the last two decades has come from high-tech — nearly 63 percent of job growth — that it’s easy to assume we are doing everything we can to encourage more growth.

But unfortunately, too many legislators have lost sight of what the R&D tax incentive actually does amid the larger debate over tax incentives. Some would suggest, for example, that the companies using the incentives don’t really need them, or that employers will continue to expand and locate here regardless of what happens in Olympia.

That’s not the case.

It’s important to remember that the R&D tax incentive program isn’t simply a tax break for employers that operate in certain sectors, but rather it’s targeted specifically at encouraging activity that drives new or improved products.

Make a great widget? That’s fine, but it’s not R&D. You need to be working on inventing the next widget in order to qualify for the program.

This kind of work requires incentives because it doesn’t always pay off for the creators of new ideas. That’s according to the economist Enrico Moretti, whose work is cited in a report on Washington’s R&D tax policy published earlier this year by the Washington Research Council.

According to Moretti, innovative companies that invest in research only reap some of the benefits of their effort, while other companies that locate near them — in a cluster — benefit from the spillover. The spillover benefit is good for a region, but companies need an R&D tax incentive in order to compensate them for the gap in their return on investment.

This is exactly why the majority of states provide tax incentives for R&D work. Starting next year, Washington will be out of step with the rest of the country.

And simply banking on the hope that tech companies love Washington and will continue to expand and locate here regardless of whether we offer an R&D tax incentive isn’t a good strategy.

Texas tried that approach and it didn’t work.

For years, Texas was one of the majority of states that offered an R&D tax incentive, but it ended in 2007, making it just one of eight states in the country without the incentive.

Texas lawmakers brought it back at the start of this year after estimating the state lost more than $3 billion in economic activity and 20,000 jobs during its absence.

Washington shouldn’t have to drop the R&D tax incentive to figure out that it’s been a success. We know, for example, that it’s responsible for 209,000 direct jobs as of 2012 and $2.9 billion of sales and B&O tax revenue.

And we know that it’s helping every part of the state. Since 1995, companies in 34 of Washington’s 39 counties have used the B&O credit to invest in research and development.

Lawmakers missed their chance this year to prevent the R&D tax incentives from expiring. Let’s hope they act quickly during the next legislative session to ensure that the absence is short-lived.

Kris Johnson is president of the Association of Washington Business, Washington state’s chamber of commerce and manufacturing association.