December 1, 2021
As California reflects on how to create more, better-paying jobs, our dominance in high-tech industries provides a unique set of tools to provide residents with economic opportunities. But the Golden State risks wasting its advantages without new approaches to developing and retaining innovative talent, especially as high-tech industries are drawn to incentives in other places.
California’s knowledge-based economic development base has long been strengthened by its research and development credit. Created in 1987, it offers companies carrying out qualified research activities a 15% tax credit on overall expenditure and a 24% tax credit on basic research, including salaries paid to employees carrying out or supervising R&D.
While the specific effects of credit on investment are difficult to quantify, various studies have demonstrated the effectiveness of similar research credits, and local businesses have cited its influence on their planning.
In 2015, the Milken Institute analyzed the effectiveness of R&D credit in our report “California’s Innovation Economy”. Our report suggested benefits of expanding credit, particularly in helping to offset high local operating costs. However, as many of these costs have continued to rise, heads of state have prioritized short-term concerns at the expense of maintaining the state’s long-term comparative advantage in innovation.
When the state faced a projected $ 54 billion deficit during the early stages of the pandemic, policymakers capped corporate tax incentives, including R&D credit, for three years. Despite protecting the state’s fiscal outlook by increasing general fund revenues, the move increased cost uncertainty for businesses at a time when economic volatility was already high.
For three decades, this incentive has helped companies reduce the risks inherent in investing in product and process improvement, but the policy change signaled a lesser commitment to innovation-driven growth. .
There were already signs that California’s advantage in high-tech employment was starting to wane. In sectors where R&D is the cornerstone of companies’ ability to compete for market share, such as IT and information; architecture and engineering; life sciences and physics; and the arts, entertainment and media – the proportion of state residents employed in 2015 was 26% higher than it was nationally (8.7% to 6.9%, respectively) according to the United States Bureau of Labor Statistics. By May 2020, California’s advantage had fallen to 20% from the national average (8.9% to 7.4%). And since last year, several leading high-tech companies have announced their departure from the state.
California is now at an inflection point, with a projected surplus of $ 31 billion but no clear commitment to restore R&D credit. Analysis from the Milken Institute’s new report: “Sustaining California’s Innovation Economy Through Investments in R&D” illustrates the continued value of R&D in terms of supporting the growth of high-paying jobs in California as well as providing the necessary investment to capture a wider range of hub innovations.
By comparing the state’s R&D credit with similar incentives in other states, we also seek to promote a conversation to ensure that innovation-driven companies choose to seek growth opportunities in the Golden State.
Our new report provides three main suggestions for heads of state:
- Reintroduce the provision for net operating loss. Relatively newer companies – including pre-revenue stage startups and companies that have yet to make a profit – are not generating enough revenue for credit to provide a clear incentive to invest in R&D.
- Offer refundable and redeemable R&D credits for small businesses. Small businesses create a disproportionate share of new jobs and can be major sources of innovation and entrepreneurship.
- Provide additional incentives to invest in basic research. Providing incentives for the private sector to invest in basic research – including sponsorship of university research which may take longer to bear fruit commercially – helps reduce marginal research costs and offers employment prospects for graduates.
As businesses and enterprises reorient themselves to the realities of burgeoning remote working and employees leaving the workforce, California cannot rest if it is to maintain its competitive edge in innovation while at the same time. minimizing the number of companies developing their R&D activities elsewhere.
Through bold actions, heads of state can also send a clear signal of their commitment to supporting the state’s most innovative companies. Not only will this restore competitiveness by providing incentives for R&D in the state, but these investments can also generate new assets – from jobs to patents and license revenues – that support more inclusive economic opportunities in the state.
Matt Horton is Director and Aaron Melaas Associate Director at the Milken Institute’s Center for Regional Economics. They wrote this for CalMatters, a public service journalism firm committed to explaining how the California Capitol works and why it matters.
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