Within the United States taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. code, the treatment of research and development (R&D) expenditures shapes where, how, and whether American companies choose to innovate and invest.
Under Section 174A, taxpayers can choose either to immediately deduct domestic R&D or to amortize it over a period of at least 60 months. While the former is superior to the latter in most cases, a taxpayer might elect amortization to smooth the deduction into future years if they are effectively unable to use the full value of expensing immediately (e.g., because they have a net operating loss).
By contrast, foreign R&D gets no such option. Under Section 174, it must be capitalized and amortized over 15 years, with no ability to expense R&D immediately. The divergence between these two R&D tax regimes is a relatively recent phenomenon. In the 2020s, the US briefly had Section 174 amortization for all R&D, which was criticized by Tax Foundation at the time, but reversed course for domestic R&D under the One Big Beautiful Bill Act (OBBBA). Motivations for excluding foreign R&D from this reversal could include reducing the budgetary cost of the law and encouraging onshoring of R&D.
However, two drawbacks are worth serious consideration. First, reduced R&D investment abroad may diminish US production and investment rather than increase it. And second, a less competitive global regime for US-resident companies may discourage US tax residence at the margin.
The Effects of Amortization and Expensing on Marginal R&D
Amortization and expensing differ only in their timing, but timing can play a critical role in the effects of tax policy on investment behavior, where firms consider the time value of money as well as present and future revenues, expenses, and tax payments. This was explored by Robert Hall and Dale Jorgenson in a foundational 1967 research paper.
Using the paper’s framework, a regime with full expensingFull expensing allows businesses to immediately deduct the full cost of certain investments in new or improved technology, equipment, or buildings. It alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs. has no impact on marginal investment—that is, investment on the cusp of being worthwhile. However, one without expensing creates a positive tax burden and leads to some projects being abandoned purely for tax reasons.
Think of the user cost of capital, c, as the hurdle rate a project must clear before a firm will bother investing. Anything that pushes c up discourages investment at the margin. The standard formula for the Hall-Jorgenson framework is:
A key variable in that formula, often written as z, captures the present value of the tax deductions a firm can claim on an investment, in an interaction with the tax rate, τ. When z equals 1, meaning the firm recovers the full value of its investment in tax deductions immediately, the tax term in the cost-of-capital formula cancels entirely, and collapses to exactly what it would be with no corporate tax at all, determined only by the interest rate r and the depreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and disco of the investment δ. The effective marginal tax rate on a breakeven investment is zero.
Full expensing is what delivers that result. The government effectively hands the firm back a slice of the investment’s cost upfront, and that immediate benefit offsets the extra tax the government will later collect on the income a marginal project generates.
Amortization does the opposite. By spreading deductions over 15 years without any expensing option pushes z below 1. That drives the user cost of capital above where it lies in the no-tax baseline, raising the hurdle rate. The tax now is a disincentive at the margin. Under the current US tax system, domestic R&D can avoid this; foreign R&D cannot.
Notably, the Hall-Jorgenson method above is for new marginal investments, so the appearance of no tax under these calculations does not mean a tax system as a whole raises no revenue. An inframarginal investment—that is, one whose benefits significantly exceed its costs in present value—would still have a positive tax burden. Likewise, pre-existing investments still generate new taxable income and tax regardless of depreciation schedule.
A Complement, not a Substitute
Thus far, we have compared the tax treatment of domestic R&D and international R&D. This does not imply, however, that the two are in competition with each other. A lawmaker working from a framework where domestic and international R&D compete might consider taxing the latter more heavily to “onshore” R&D. But this would be a mistake. International R&D is typically complementary to domestic activities, enhancing and scaling them rather than replacing them.
For example, one function of R&D is market adaptation: making a US-developed product compatible with foreign language, climate, infrastructure, or payment systems so that it can be exported. This can also include acquiring approval from foreign regulatory systems (e.g., in workplace safety or pharmaceutical clinical trials).
Another common pattern for foreign R&D is the acquisition of foreign research teams; a valuable idea, like a software or pharmaceutical patent, generated outside the US might prove useful and scale itself quickly with the aid of a large US company’s infrastructure. To achieve this, a US company might make further investments in the US.
Both economic research institutions and business organizations have noted this complementarity. Economists Gary Hufbauer, Theodore Moran, and Lindsay Oldenski wrote a book on the interaction of outbound foreign direct investment with the US economy in general, and studied R&D complementarity in one of the chapters, finding that “global R&D expenditures and operations of US MNCs may create complementary capabilities and interdependent competencies, rather than simply displacing one capability or competency from location A to location B.”
Further commentary by Moran and Oldenski argues that “measures to hinder or slow the globalization of R&D by US [multinational corporations] will stifle R&D by those multinationals in the United States.” The Information Technology and Innovation Foundation also finds that offshore research tends to complement domestic innovation rather than compete with it. This occurs through accelerating localized product adaptation and expanding a firm’s broader knowledge network.
Overall, penalizing foreign R&D is more likely to reduce a US company’s total cross-border knowledge production than produce gains at home.
Effects on Mergers and Acquisitions
One phenomenon mentioned above—acquired foreign research teams—merits additional discussion. Harsher US tax rules on foreign earnings make US companies less competitive bidders in cross-border mergers and acquisitions (M&A). Imagine a foreign acquisition target that is R&D-heavy. If its future spending will be amortized over 15 years for a US acquirer but expensed immediately by a foreign competitor, the US firm’s after-tax valuation of that target is structurally lower, and it may lose the bidding war.
The Semiconductor Industry Association argues, for example, that US chip firms face a disadvantage when competing globally for innovative assets because foreign rivals receive more favorable treatment for research spending. But this insight could also apply equally to many other industries, such as the M&A-heavy pharmaceutical industry.
Therefore, the loss of some M&A transactions could not only harm the US economy via the complementarity mentioned above, but it could also reduce the global reach and revenue-generation capacity of the US tax regime, since fewer businesses would fall under its purview.
The United States should move toward a neutral tax treatment of R&D expenditure, regardless of where they occur. Policymakers should avoid creating disadvantages that disproportionately burden foreign R&D performed by US MNEs. This approach would encourage US firms to expand their overall innovation activity and improve the ability of US firms to compete for foreign acquisitions.
Taxes make more sense with us in your inbox.
Subscribe to our newsletter for tax insights that cut through the noise—and make sense of it.
Sign Up
Share this article
