Hooray For R. and D.

By Daniel Kadlec

The spate of recent tax bills landing on President Clinton's desk, where they will die or have already died, offers a glimpse of what voters can expect under a Gore or Bush Administration next year. Bush supports the bills. He would eliminate the estate tax and marriage penalty and expand tax-deferred savings for everyone. Gore opposes them, preferring modest tax cuts targeted at middle- and lower-income households.

The two have found common ground, though, on at least one tax initiative. Both would like to make permanent a tax credit for companies engaging in costly research and development. Signed into law in 1981--but needing reauthorization every few years--the R.-and-D. tax credit is designed to spur innovation by reimbursing companies for some of the costs of engineering better mousetraps.

The credit, often used to hire researchers, is for 20% of R.-and-D. spending over a base amount typically defined by spending patterns for the preceding three years. There is no dollar limit, and the credit can be claimed every year.

The credit is hugely popular in Silicon Valley and among biotechnology and large pharmaceuticals companies. R. and D. is their lifeblood. Such companies depend on a constant flow of new drugs and gadgets. But is it right that they slough off onto taxpayers part of their R.-and-D. tab? It seems a difficult argument to support, given how much money is to be made once a new drug or technology reaches the marketplace.

Some companies and entrepreneurs are willing to shoulder the risk alone. Take Scott Martin, CEO of software developer diCarta in Redwood City, Calif. His firm will spend $4.5 million on R. and D. this year and claim a $100,000 tax credit. Martin readily admits he would be spending at his current pace even without the R.-and-D. credit. "We're a start-up," he says. "We have to spend, or we're dead."

Yet there is a limit to how much money private industry is willing to gamble on products that may or may not pan out. If a government kickback for research increases the amount of research being done, then it has value to the economy and society in ways that are hard to measure.

Consider the plight of biotech firm Genentech in the early '90s. It had four promising drugs that it wanted to take into clinical trials one year, but it had resources for only three. On the bubble: the breast-cancer drug Herceptin. The R.-and-D. tax credit provided funds for Genentech to proceed with that fourth drug, which came to market last year and is now saving lives while ringing up sales of $75 million a quarter. With the tax credit, says Walter Moore, vice president of government affairs at Genentech, his company is able to pursue one additional drug every year.

Murray Gerber, founder of Prototype & Plastic Mold Co., based in Middleton, Conn., developed lighter, safer, cheaper, longer-lasting industrial bearings for United Technologies in the '90s. Without the tax credit, which went to United Technologies, Gerber doubts that his tiny, $9 million company would have received the R.-and-D. contract. Now those bearings are in wide use throughout the military.

Numerous studies have indicated that the tax credit pays for itself by creating jobs, as well as stirring innovation that leads to greater worker productivity. In 1998 Coopers & Lybrand concluded that the economic benefits would be far greater if the credit were made permanent. Under such a scenario, total R.-and-D. spending would jump $41 billion over 12 years.

It's not all that costly anyway. The total government outlay is $2.2 billion a year. With budget surpluses running high, that's a small investment in innovation. Do we want new drugs like Herceptin? They can take 10 to 12 years to reach market and cost $300 million or more to develop. The credit not only helps underwrite that endeavor but also adds tangible net worth to a small firm with little or no revenue, giving Wall Street more incentive to invest and keep the company going.

The tax credit is set to expire in 2004. Yet it is working so well that even presidential candidates can't disagree. Now is the time to make it permanent. Only then will anyone address how to make it better--less confusing--which is what we really should be talking about.

Written in coordination with FSB, a Time Inc. magazine for small-business owners