Testimony from June 14, 1999

 

Prepared Testimony from Judy Carter, Softworks

Mr. Chairman and members of the committee, my name is Judy Carter, and I am the Chief Executive
Officer and President of Softworks of Alexandria, Virginia. I applaud your leadership in convening this
event, and thank you for the opportunity to submit this statement as part of the National Summit on High
Technology. Like you, I believe that our nation's economic growth and our citizens' employment arc
inextricably tied to national advances in high technology.

Softworks has been in the information technology business for 21 years - during this time we have both
contributed to and benefited from the evolution of information and computing technology. We are a global
company with software solutions that are sold in every major market around the world. We have offices
in the UK, France, Italy, Spain, Germany, Japan, Australia and Brazil, as well as thirteen offices
throughout the U.S. and Canada. We have over 2000 customers worldwide including 87 of the Fortune
100 companies and about 58% of the Fortune 500. Importantly, we currently employ over two hundred
workers in the United States.

As the Committee members consider technology issues in the 106th Congress, I encourage them to
endorse fiscal policies and initiatives that will fuel the U.S. economy, keeping American companies and
their workers prosperous and competitive in the changing global marketplace as we enter the 21st century.
Without a growing economy, Americans' standard of living, and our ability to support the needs of our
aging population, will be in jeopardy. Faced with a static or decreasing workforce as U.S. demographics
shift, U.S. lawmakers must focus on encouraging technology development to increase productivity,
enabling a smaller workforce to support a growing population of retirees.

Increased technology development will help to ensure sustained economic growth and the prosperous
environment needed to continue to improve our standard of living for current and future generations of
Americans, will permit additional individual tax reductions, and will ensure a growing economy with
resources necessary, to adequately support the health and retirement needs of an aging U.S. population.
While much of this activity, clearly, must be accomplished by the private sector, there are a number of
things that the federal government can do to allow and encourage companies like mine to continuously
innovate. Better protection under patent law, relief from the compliance burden imposed by federal
regulations, and decreased tax rates on investment income all would allow Softworks and other US
high-tech firms to allocate more resources to research and experimentation.

The R&D tax credit, which will be the principal focus of my testimony today, is believed by many
government and private sector experts to be one of the most effective, proven means of generating
increased research and development activity, which in turn will provide the technology improvements to
benefit the economy. Last year the accounting firm of Coopers & Lybrand (now
PricewaterhouseCoopers) completed a new study, Economic Benefits of the R&D Tax Credit, (January,
1998) that dramatically illustrates the significant economic benefits provided by the credit, and further
reinforces the need to make the credit permanent. According to the study, making the R&D credit
permanent would stimulate substantial amounts of additional R&D, increase national productivity and
economic growth almost immediately, and provide U.S. workers with higher wages and after-tax income.

I. R&D CREDIT LEGISLATIVE HISTORY
The R&D credit was enacted in 1981 to provide an incentive for companies to increase their U.S. R&D
activities. As originally passed, the R&D credit was to expire at the end of 1985. Recognizing the
importance and effectiveness of the provisions, Congress decided to extend it. In fact, since 1981 the
credit has been extended nine times. In addition, the credit's focus has been sharpened by limiting both
qualifying activities and eligible expenditures. With each extension, the Congress indicated its strong
bipartisan support for the R&D credit.

In 1986, the credit lapsed, but was retroactively extended and the rate cut from 25 percent to 20 percent.
In 1988, the credit was extended for one year. However, the credit's effectiveness was further reduced by
decreasing the deduction for R&D expenditures by 50% of the credit. In 1989, Congress extended the
credit for another year and made changes that were intended to increase the incentive effect for
established as well as start-up companies. In the 1990 Budget Reconciliation Act, the credit was extended
again for 15 months through the end of 1991. The credit was again extended through June 30, 1992, by
the Tax Extension Act of 1991. In OBRA 1993, the credit was retroactively extended through June 30,
1995.

In 1996, as part of the Small Business Job Protection Act of 1996, the credit was extended for eleven
months, through May 3 I, 1997, but was not extended to provide continuity over the period July 1, 1995
to June 30, 1996. This one-year period, July 1, 1995 to June 30, 1996, was the first gap in the credit's
availability since its enactment in 1981.

In 1996, the elective Alternative Incremental Research Credit ("AIRC") was added to the credit,
increasing its flexibility and making the credit available to R&D intensive industries which could not
qualify for the credit under the regular criteria. The AIRC adds flexibility to the credit to address changes
in business models and R&D spending patterns, which are a normal part of a company's life cycle. The
sponsors of S. 680 and HR. 835 recognize the importance of the AIRC. Their legislation, in addition to
making the credit permanent, provides for a modest increase in the AIRC rates that will bring the AIRC's
incentive effect more into line with the incentive provided by the regular credit to other research-intensive
companies.

The Congress next approved a thirteen-month extension of the R&D credit that was enacted into law as
part of the Taxpayer Relief Act of 1997. The credit was made available for expenditures incurred from
June 1, 1997 through June 30, 1998, with no gap between this and the previous extension. Most recently,
the Congress approved a one-year extension of the credit, until June 30, 1999.

According to the Tax Reform Act of 1986, the R&D credit was originally limited to a five-year term in
order "to enable the Congress to evaluate the operation of the credit." While it is understandable that the
Congress in 1981 would want to adopt this new credit on a trial basis, the credit has long since proven
over the sixteen years of its existence to be an excellent highly leveraged investment of government
resources to provide an effective incentive for companies to increase their U.S.-based R&D.
The historical pattern of temporarily extending the credit, combined with the first gap in the credit's
availability,, reduces the incentive effect of the credit. The U.S. research community needs a stable,
consistent R&D credit in order to maximize its incentive value and its contribution to the nation's
economic growth and sustain the basis for ongoing technology competitiveness in the global arena.

WHY DO WE NEED A R&D CREDIT?
A. The credit offsets the tendency for under investment in R&D
The single biggest factor driving productivity growth is innovation As stated by the Office of Technology
Assessment in 1995: "Much of the growth in national productivity ultimately derives from research and
development conducted in private industry." Sixty-six to eighty percent of productivity growth since the
Great Depression is attributable to innovation. In an industrialized society R&D is the primary means by
which technological innovation is generated.

Companies cannot capture fully the rewards of their innovations because they cannot control the indirect
benefits of their technology on the economy. As a result, the rate of return to society from innovation is
twice that which accrues to the individual company. This situation is aggravated by the high risk
associated with R&D expenditures. As many as eighty percent of such projects are believed to be
economic failures.

Therefore, economists and technicians who have studied the issue are nearly unanimous that the
government should intervene to increase R&D investment. The most recent study, conducted by the Tax
Policy Economics Group of Coopers & Lybrand, concluded that "... absent the R&D credit, the
marketplace, which normally dictates the correct allocation of resources among different economic
activities, would fail to capture the extensive spillover benefits of R&D spending that raise productivity,
lower prices, and improve international trade for all sectors of the economy". Stimulating private sector
R&D is particularly critical in light of the decline in government funded R&D over the years. Direct
government R&D funding has declined from 57% to 36% of total R&D spending in the U.S. from 1970
to 1994. Over this same period, the private sector has become the dominant source of R&D funding,
increasing from 40% to 60%.

B. The credit helps U.S. business remain competitive in a world marketplace
The R&D credit has played a significant role in placing American businesses ahead of their international
competition in developing and marketing new products. It has assisted in the development of new and
innovative products; providing technological advancement, more and better U.S. jobs, and increased
domestic productivity and economic growth. This is increasingly true in our knowledge and information-
driven world marketplace.

Research and development must meet the pace of competition. In many instances, the life cycle of new
products is continually shrinking. As a result, the pressure of getting new products to market is intense.
Without robust R&D incentives encouraging these efforts, the ability to compete in world markets is
diminished.

Continued private sector R&D is critical to the technological innovation and productivity advances that
will maintain U.S. leadership in the world marketplace. Since 1981, when the credit was first adopted,
there have been dramatic gains in R&D spending. Unfortunately, our nation's private sector investment in
R&D (as a percentage of GDP) lags far below many of our major foreign competitors. For example, U.S.
firms spend (as a percentage of GDP) only one-third as much as their German counterparts on R&D, and
only about two-thirds as much as Japanese firms. This trend must not be allowed to continue if our nation
is to remain competitive in the world marketplace.

Moreover, we can no longer assume that American companies will automatically choose to site their R&D
functions in the United States. Foreign governments are competing aggressively for U.S. research
investments by offering substantial tax and other financial incentives. Even without these tax incentives,
the cost of performing R&D in many foreign jurisdictions is lower than the cost to perform equivalent
R&D in the U.S.

An OECD survey of sixteen member countries found that thirteen offer R&D tax incentives. Of the
sixteen OECD nations surveyed, twelve provide a R&D tax credit or allow a deduction for more than
100% of R&D expenses. Six OECD nations provide accelerated depreciation for R&D capital. According
to the OECD survey, the U.S. R&D tax credit as a percentage of industry-funded R&D was third lowest
among nine countries analyzed.

Making the U.S. R&D tax credit permanent, however, would markedly improve U.S. competitiveness in
world markets. The 1998 Coopers & Lybrand study found that, with a permanent credit, annual exports
of goods manufactured here would increase by more than $6 billion, and imports of good manufactured
elsewhere would decrease by nearly $3 billion. Congress and the Administration must make a strong and
permanent commitment to attracting and retaining R&D investment in the United States. The best way to
do that is to permanently extend the R&D credit.

C. The credit provides a targeted incentive for additional R&D investment, increasing the amount of
capital available for innovative and risky ventures The R&D credit reduces the cost of capital for
businesses that increase their R&D spending, thus increasing capital available for risky, research ventures.

Products resulting from R&D must be evaluated for their financial viability. Market factors are providing
increasing incentives for controlling the costs of business, including R&D. Based on the cost of R&D, the
threshold for acceptable risk either rises or falls. When the cost of R&D is reduced, the private sector is
likely to perform more of it. In most situations, the greater the scope of R&D activities, or risk, the
greater the potential for return to investors, employees and society at large.

The R&D credit is a vital tool to keep U.S. industry competitive because it frees-up capital to invest in
leading edge technology and innovation. It makes available additional financial resources to companies
seeking to accelerate research efforts. It lowers the economic risk to companies seeking to initiate new
research, which will potentially lead to enhanced productivity and overall economic growth.
D. Private industrial R&D spending is very responsive to the R&D credit, making the credit a cost
effective tool to encourage economic growth

Economic studies of the credit, including the Coopers & Lybrand 1998 study, the KPMG Peat Marwick
1994 study, and the article by B. Hall entitled: "R&D Tax Policy in the 1980s: Success or Failure?" Tax
Policy and the Economy (1993), have found that a one-dollar reduction in the after-tax price of R&D
stimulates approximately one dollar of additional private R&D spending in the short-run, and about two
dollars of additional R&D in the long run. The Coopers & Lybrand study predicts that a permanent R&D
credit would lead U.S. companies to spend $41 billion more (I 998 dollars) on R&D for the period
1998-2010 than they would in the absence of the credit. This increase in private U.S. R&D spending, the
1998 study found, would produce substantial and tangible benefits to the US. economy.

Coopers & Lybrand estimated that this permanent extension would create nearly $58 billion of economic
growth over the same 1998-2010 period, including $33 billion of additional domestic consumption and
$12 billion of additional business investment. These benefits, the 1998 study found, stemmed from
substantial productivity increases that could add more than $13 billion per year of increased productive
capacity to the U.S. economy. Enacting a permanent R&D credit would lead U.S. companies to perform
significantly more R&D, substantially increase U.S. workers' productivity, and dramatically grow the
domestic economy.

E. Research and Development is About Jobs and People
Investment in R&D is ultimately an investment in people, their education, their jobs, their economic
security, and their standard of living. Dollars spent on R&D are primarily spent on salaries for engineers,
researchers and technicians.
When taken to market as new products, incentives that support R&D translate to salaries of employees in
manufacturing, administration and sales. Of exceptional importance to Softworks and the other members
of the R&D Credit Coalition, R&D success also means salaries to the people in our distribution channels
who bring our products to our customers as well as service providers and developers of complementary
products. And, our customers ultimately drive the entire process by the value they put on the benefit to
them of advances in technology (benefits that often translate into improving their ability to compete). By
making other industries more competitive, research within one industry contributes to preserving and
creating jobs across the entire economy.
 

My experience has been that more than 75 percent of expenses qualifying for the R&D credit go to
salaries for researchers and technicians, providing high-skilled, high-wage jobs to U.S. workers.
Investment in R&D, in people working to develop new ideas, is one of the most effective strategies for
U.S. economic growth and competitive vitality. Indeed, the 1998 Coopers & Lybrand study shows
improved worker productivity throughout the economy and the resulting wage gains going to hi-tech and
low-tech workers alike. U.S. workers' personal income over the 1998-2010 period, the 1998 study
predicts, would increase by more than $61 billion if the credit were permanently extended.
F. The R&D credit is a market driven incentive

The R&D credit is a meaningful, market-driven tool to encourage private sector investment in research
and development expenditures. Any taxpayer that increases their R&D spending and meets the technical
requirements provided in the law can qualify for the credit. Instead of relying on government-directed and
controlled R&D spending, businesses of all sizes, and in all industries, can best determine what types of
products and technology to invest in so that they can ensure their competitiveness in the world
marketplace.

III. THE R&D CREDIT SHOULD BE MADE PERMANENT TO HAVE MAXIMUM INCENTIVE
EFFECT
As the Joint Committee on Taxation points out in the Description of Revenue Provisions in the President's
Fiscal Year 2000 Budget Proposal (JCS-1-99), "If a taxpayer considers an incremental research project,
the lack of certainty regarding the availability of future credits increases the financial risk of the
expenditure." Research projects cannot be turned off and on like a light switch; if corporate managers are
going to take the benefits of the R&D credit into account in planning future research projects, they need
to know that the credit will be available to their companies for the years in which the research is to be
performed. Research projects have long horizons and extended gestation periods. Furthermore, firms
generally face longer lags in adjusting their R&D investments compared, for example, to adjusting their
investments in physical capital.

In order to increase their R&D efforts, businesses must search for, hire, and train scientists, engineers and
support staff. They must often invest in new physical plants and equipment. There is little doubt that a
portion of the incentive effect of the credit has been lost over the past seventeen years as a result of the
constant uncertainty over the continued availability of the credit.

If the credit is to provide its maximum potential for increased R&D activity, the practice of periodically
extending the credit for short periods, and then allowing it to lapse, must be eliminated, and the credit
must be made permanent. Only then will the full potential of its incentive effect be felt across all the
sectors of our economy.

IV. CONCLUSION
Making the existing R&D credit permanent best serves the country's long term economic interests as it
will eliminate the uncertainty over the credit's future and allow R&D performing businesses to make
important long-term business decisions regarding research spending and investment. Private sector R&D
stimulates investment in innovative products and processes that greatly contribute to overall economic
growth, increased productivity, new and better U.S. jobs, and higher standards of living in the United
States. Moreover, by creating an environment favorable to private sector R&D investment, jobs will
remain in the United States. Investment in R&D is an investment in people. A permanent R&D credit is
essential for the United States economy in order for its industries to compete globally, as international
competitors have chosen to offer direct financial subsidies and reduced capital cost incentives to "key"
industries. I strongly support the permanent extension of the R&D credit, and increasing the AIRC rates
by 1%, and urge Congress to enact the provisions of S. 680 - H.R. 835 before the credit expires on June
30, 1999.