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Is The Government Stifling Innovation?

Research and Development Cuts Hurt the Most

Written by Briton Ryle
Posted March 17, 2014

This is an issue that is borderline anti-capitalist, some would even say it's so far over the line that it's almost socialist. It’s about taxes, fees, and a whole slew of worker benefits imposed on corporations by government.

Washington is bleeding corporations of more and more of their profits to support social programs, healthcare, retirement contribution matching, maternity leave, and so on – expenses which could be better spent on researching and developing new products, improving operations and gaining market share.

On the flip side of the debate, however, those hard-earned profits were hard-earned by the very employees corporations are complaining about having to support – without whom there would be no hard-earned profits at all.

For a moment, let’s put aside the labels just long enough to at least weigh both side of the debate: Are government demands on business too exorbitant, or are corporations misprioritizing?

Government Impositions

Let’s first take a look at some of the ways the government is cutting into the profits of corporations and small business:

• Minimum wage to increase by nearly 40 percent from $7.25 to $10.10 per hour. Ouch! That’s gotta hurt when labor costs rise by 40 percent. But the pain is going to be felt by companies one way or another. A full-time minimum wage worker currently earns around $15,000 a year. After income tax do they even take home $1,000 a month? In order to reduce the amount it spends on food stamps and other low-income support benefits, the government is shifting part of the burden onto corporations and small businesses, obliging them to pay each minimum wage worker an additional 40 percent, amounting to an extra $6,000 a year for each full-timer.

• The employer mandate obliging businesses with 50 or more 30-hours-per-week workers to cover their health insurance. Again, it comes down to shifting the burden off of government and onto businesses.

• The reduction of accelerated depreciation tax breaks on capital purchases. Up until 2013, companies were allowed to write off the depreciation of equipment and other capital purchases at a faster rate up to a limit of $500,000 a year. As of 2014, that accelerated capital depreciation limit has been severely slashed to a maximum of just $25,000 per year.

• The special Research & Experimentation Tax Credit, or the R&D Tax Credit, begun in 1981 has also expired at the end of 2013. A study by Ernst and Young in 2005 reported that 17,700 corporations claimed $6.6 billion in R&D tax credits that year. Government estimates put the current figure at over $10 billion a year worth of credits, revenue which the government sorely wants to stop losing.

• And just more plain old taxes… including a higher capital gains tax rate, higher tax rates on the highest income bracket, higher Medicare taxes, and Social Security taxes restored to their original higher rates.

Implications on Corporations and Small Businesses

It doesn’t take an accountant to realize that taking more money away from companies leaves them with less capital to reinvest in their businesses.

In an era of growing competition from international companies – many of whom are state-sponsored with huge R&D breaks and budgets – one has to question the sanity of continually dumping more and more burdens on America’s companies, many of which are still struggling after the recent Great Recession.

Just look at the unemployment levels for evidence of a still-ailing recovery. While the unemployment rate may have retreated from 10 percent in 2010 to 6.7 percent currently, the number of employed persons has actually fallen – from 146.5 million employed in 2007 to 145.3 million employed today.

That doesn’t even count the growing population since 2007. Factor-in population growth and we have a recovery in name only, as the current number of unemployed persons at 10.4 million – though slowing improving – is still much higher than the 7 million of 2007.

Unemployment USA

Source: TradingEconomics.com

Is this the time to be raising tax rates and reducing tax credits to pre-recession levels when the employment situation is clearly still so much worse than it was then? Any money bled out of companies big or small is only going to result in a slower economic recovery, as businesses will be forced to cut costs to pay those extra taxes and fees.

Among the first costs cut are labor and R&D, stifling job creation and innovation, and causing American companies to lose market share to companies abroad that enjoy tax breaks from governments who understand the importance of continually researching new products and improving existing ones.

A recent report by Battelle Memorial Institute on global R&D spending shows how China is on pace to surpass the U.S. in annual R&D funding by the year 2023 – in less than 10 years – as illustrated in the graph below.

R%26D funding china%2C usa

Source: Battelle and R&D Magazine

Ranking countries in R&D spending as a percentage of GDP, the Battelle report shows the U.S.’s 2.8 percent of GDP devoted to R&D ranks in 9th place behind Israel’s 4.2, South Korea’s 3.6, Finland’s 3.5, Japan’s andSweden’s 3.4, and Germany’s, Switzerland’s and Denmark’s 2.9 percent of GDP.

Forcing Corporate Responsibility

On the other hand… yes, this is the part I warned you about at the outset… we can’t complain about big government and out-of-control government spending and simultaneously complain when government tries to downsize and reduce its spending.

There are only two ways a government can downside – cut expenses that can be reduced, or pass expenses that can’t be reduced onto individuals and businesses.

Indeed, the passing of expenses onto corporations is somewhat unfair on the companies at first glance. But the process forces corporations to tighten their belts and reduce their own excessive misappropriated overspending.
What excessive misappropriated overspending? Those absurd executive compensation packages from million-dollar signing bonuses before they’ve begun working to multimillion-dollar severance packages just for quitting. Some CEOs have even received $3 million, $4 million, $5 million and more when they were fired from their jobs for being incompetent!

I wonder how much R&D those severance packages would have financed? Or how many workers’ wages they would have covered?

The answer to that second question is 190.

A single $4 million severance payout could cover the annual wages of 190 full-time minimum wage employees – at the higher $10.10 hourly rate.

Then there are those performance bonuses for simply doing one’s job, like investment banking traders and investment managers collecting annual bonuses of anywhere from $100,000 to $1 million each simply for not losing their firms' money. Do their security guards get any bonus at all for preventing break-ins, thefts and the loss of company merchandise?

Strategic Strikes Over Carpet Bombing

Naturally, excessive taxes and fees on small businesses need to be seriously re-examined, since most are struggling just to survive, and their lower capital reserves leave them highly vulnerable to a sudden increase in taxes and fees. But don’t shed a single tear for the corporations who have demonstrated far poorer judgement managing their revenues than even the government itself.

Perhaps the government’s finance department should consult with the military to learn the difference between carpet bombing and precision strikes. With such a wide range of business sizes from your sole-proprietor and small Mom-and-Pop shops, all the way up to your mega cap multinational conglomerates – it would simply be unreasonable and outright cruel to impose taxes and fees as a fixed percentage clear across the board.

A one percent increase on anything means far more to a flower shop than that same one percent increase means to a bank.

The rest is up to the companies themselves. In this day and age of increased competition, businesses andgovernments alike must be lean to survive. Corporations need to decide which is more important to them – outrageous executive compensations or improving their product line through meaningful R&D. 

They cannot gripe about higher taxes that stifle their growth and then generously pay extraordinary bonuses and perks to personnel who already earn more than $50,000 a year as a regular salary, not to mention multimillion dollar compensations to executives for work not yet performed and for work poorly performed.

If a corporation falls behind its competition in R&D, sales or market share, you can bet there were other reasons behind it than the increase of a few taxes.

Joseph Cafariello

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