Introduction

Tax incentives are the exemptions or reduction of tax rates by the government with the aim of benefiting a particular subset of the taxpayers. A government may generate revenue for its expenditures by either increasing tax rates or by reducing them to encourage investments (Abeler&Jäger, 2015). Companies, whether domestic or foreign, are attracted to countries where the taxes are quite low, which is advantageous to their profits. It is an indirect form of revenue generation by the government because the companies will be able to enhance developments in particular areas. For instance, if a big company is set up in a less-developed area, there will be an improvement of infrastructure and the living standards of the surrounding residents due to employment.

However, some of the outcomes expected from this tax system are still theoretical. As such, there are several conflicting opinions from the public with some saying that it is not as effective while others believe that it could be a significant program if specific changes happen. Whether tax credits can attract investments is a debatable subject and is a matter that is entirely dependent on investors’ interests. There are many tax programs are offered by the United States government, but they could be made more effective through one or two changes. This paper will cover four specific incentives and how they can be restructured to have the desired outcome.

1. Credit For Increasing Research Activities

Overview

Under Section 41 of the Internal Revenue Code, a taxpayer must show that its research activities meet three tests to be eligible for the research and development credits by the United States government. In meeting the tests, the research should show that it is crucial to the development of a new or improved business component of the taxpayer (Sammartino& Reuben, 2016). This research has to be for finding or discovering information that is technological. The last being all the activities should have components of a process of experimentation for a purpose. Some of the options considered in Section 41 as eligible for credits include Computer Software. Tax Reform Act of 1986 specifies computer software as part of a business component. Thus activities for development of software will generally meet process or product development activities. Other points are obtaining a patent and acquiring an already patented product and the sum of all research expenses both individual and contractual.

Under regulations passed out in January of 2004, research undertaken for purposes of discovering new information to eliminate uncertainty about development or improve a business factor is eligible for tax credits (Shepherd, 2017). The experimentation process of the discovery must use principles of computer science, engineering, or biological/physical sciences.

The Effectiveness of The Program

Initial studies show that tax credits stimulate a general increase in spending on research on the related field affected by the program. Theoretically, growth in investment on qualified research is spurred by credit as it lowers the after-tax cost. What this means is that the credit reduces the tax price of research and companies respond by spending more on it, with all other factors in it being equal. Joint Committee on Taxation noted that in President George W. Bush’s Budget FY2004 budget request; the elasticity of price in research in respect to research expenditures is between -0.4 and -0.8, this being the short run elasticity in pricefor qualifiedresearch. More studies do show an indication of research spending as sensitive to price changes as a result of tax credits. It, therefore, means that an 8% reduction in research cost would result in a direct 8% increase in research spending. Further studies have shown that in the long run, the tax credit has a more substantial impact on expenditures for qualified research.

The Unintended Impacts of the Legislation

Given that the research and development credits lack policy of permanency, most research managers fail to consider it in the annual budgets because most research and development projects run for more than a year or two. Critics do maintain that the effects of the credits incentive are not even across the board. The critics argue this concern that it is varied among firms that conduct qualified research in many ways that are not supported by economic theory and defeat the whole purpose of the tax credit. A study by economist William Cox in 1996 found out that firms with high research intensiveness could make credit claims less than what firms whose propensity to invest is much lower.

Recommended Modifications and Their Implications

To incentivize most firms to take up their research and developments projects within the United States it would only be proper to have an even module in which the tax credit claims can be uniform across the firms. The module will, in turn, bring about an equal ratio of investment versus claims, thereby increasing the chances of having a firm raise its volume of research and development investment. The ripple effect of this would be positive changes in employment rate as well as improved infrastructures in areas where the firms are based.

The Probability of Passage

With the current Credit for Research Activities Act receiving several critics, modifications to it would spur the Congress and the Senate to work around approving proposed changes to improve the overall standing of the United States as a leader in research, development, and innovation.

2. The Work Opportunity Tax Credit

Overview

The Work Opportunity Tax Credit was introduced to incentivize employers into employing a part of the citizenry that would otherwise find it challenging to go through normal employment channels. Such include qualified veterans, qualified ex-felons, vocational rehabilitation referral, designated community residents and summer youth employees among others. The employer must have a tax liability to claim the credit as work opportunity tax credit is a non-refundable credit. This credit is a calculation of a percentage of wages paid to the worker under the eligibility bracket during the first year of employment(Abeler&Jäger, 2015). An employee with such an eligible employee can claim upto 40% of the employee’s wages given that the employee has clocked in not less than 400 hours in the first year of employment. An employer may not claim the credit if a worker has clocked less than 120 hours of work. The recent extension of WOTC was in 2015 through the Protecting Americans from Tax Hikes Act of 2015, and this is through 2019.

The Effectiveness of The Program

The Work Opportunity Tax Credit is designed to provide an added advantage to a workforce from the target group who seek to be employed. It is not structured as an avenue to create new jobs but a road map for an employer to replace an employee or have an additional employee. The population from the target groups, for example, qualified ex-felons, get to have another chance to build their lives honestly instead of having to slide back to old ways. As well, it gives a chance to the youth to develop a responsible life at an early age. On qualified veterans, it provides the opportunity for the workers to put their skills and discipline to improving their livelihoods after leaving the armed forces and not using those skills in the crime world. The most recent data available was in the Financial Year 2017 (FY2017) where about 2 million workers were eligible for the WOTC(Abeler&Jäger, 2015).

The Unintended Impacts of the Legislation

As much as the Work Opportunity Tax Credit gives an advantage to an otherwise disadvantaged workforce, it has put undue pressure on employers to hire from the target group even when there is an equally qualified candidate who is not eligible for WOTC. The current WOTC runs up to December 31^st, 2019, and as it is a temporary provision under the Internal Revenue Code, it brings anxiety and uncertainty among the workforce as any worker hired after the date, will not be eligible for the WOTC unless it extended.

Recommended Modifications and Their Implications

With the current Act, the Protecting Americans from Tax Hikes Act of 2015 set to expire December 31^st, 2019, there is a need to have a longer-term Act that would not need frequent re-evaluation. Having a separate clause for veterans and the other eligible workers should be put in the Act as well. The move will indirectly increase the number of young Americans to enlist in the armed forces will, in turn, result in a population that can relate to each other thus reduce societal parity.

The Probability of Passage

With about 97 members (18.8 percent) of the Congress having served in the military, there will be pressure from the public to pass this modification to increase future representation of the veteran population in the law houses. More accurate data would be available as well when it comes to having employers making credit claims for Work Opportunity Tax Credit.

3. The Energy Tax Credit

Overview

This tax credit is eligible to anyone who increases the efficiency and reduces wastage of energy in their homes by making use or producing of particular equipment. The taxpayers can access this incentive via the Internal Revenue Service Form 5695. Its implementation and the benefits received by the consumers depend on whether it is for residential or business purpose. The program was passed into law in 2005 and was brought back in 2018 after its expiration in 2016. Taxpayers who make energy-related improvements in their homes are eligible to 30% credit of their costs. This percentage will steadily reduce after 2019 and finally reach zero in 2021 (Shepherd, 2017).

The Effectiveness of The Program

            The energy tax credit is one of the most effective tax programs because of its impacts on American society. This incentive has encouraged most people to take a step and consider the cleanliness of their environment. The fact that it got revived in 2018 shows that it was serving its intended purpose. A high percentage of American citizens had started considering energy-efficient ways to be eligible for the energy tax credit. The idea of rewarding companies that manufacture energy-efficient products has led to the production of more environmental-friendly goods.

The Unintended Impacts of the Legislation

            The first unintended impact of this incentive is in the nuclear plants located in the United States. The plants’ operation has been affected due to the disruption of the competition in the electricity market. For instance, the electricity generation plants that make use of wind do not find it hard to pay for the congestion charges as long as the costs do not exceed the credits granted to them. Nuclear plants, on the other hand, do not have this benefit and their profits are then cut down. The competition in the electricity market has become quite unfair because nuclear plants cannot compete on the same fronts as the renewable energy facilities. Some of the companies have, therefore, had to close down their businesses. Wisconsin’s Kewaunee facility is one of the victims of this tax program. As such, many people who were working at Kewaunee lost their jobs because the nuclear plant became un-operational.

Recommended Modifications and Their Implications

The current law does not incentivize the smaller energy generation plants. Some of these facilities include small wind, landfill gas, and solar illumination. These projects have a similar environmental effect as other big environment-friendly plants. Qualified properties that make use of these resources should be allowed to enjoy the incentives. Identical to the current beneficiaries, these resources will receive 26% credit if they began their construction within 2020. Those that start their construction in 2021 will be eligible to 22% credit (Comello&Reichelstein, 2016).

Implementation of this proposal will ensure the small electricity production projects are given aid by the Federal government. AS such, more jobs will be created, hence reducing the unemployment rate. Also, there will be an increase in the GNP and the government revenue because of the jobs created and the support given to local production companies.

The Probability of Passage

            The probability of having this proposal passed into law is 50-50. One thing that would make it difficult for the government to implement it is the additional costs that come with it. The current credit program has already taken a substantial piece of the budget. However, the impacts that will occur with its implementation are beneficial both to the citizens and the government.

 

4. The Domestic Manufacturing Deduction

Overview

            The domestic manufacturing deduction, or production activities deduction, is an incentive program that the Congress passed into law about one and a half decades ago. It was a tax relief aimed at the businesses that produced a significant percentage of their goods from within the United States. This incentive, however, became outdated after the new Tax Cuts and Jobs Act of December 2017. It was, therefore, replaced with the qualified business income deduction. The current program allows the owners of S corporations, sole proprietorships, and partnerships to remove around 20% or less of the eligible business income.

The Effectiveness of the Program

            The domestic manufacturing deduction did not bear the expected fruits. The Joint Committee on Taxation once suggested that repealing the program would raise about $174 billion within the first ten years (Borenstein& Davis, 2016). The claims are yet to be, but assuming that those figures are accurate, it proves that this law was quite costly to the American citizens. The massive amount of money channeled into this program could not be such a big deal if the results were worth the amount. Another aspect that made this incentive not quite useful is the fact that the government did not specify all the activities that qualified for the deductions. As such, some of the companies could not take advantage of the opportunity presented to them.

The Unintended Impacts of the Legislation

            One of the side effects of this legislation is the distortion it brought into the economy of the country. The Congress specified that certain business activities were eligible while others would not cut into the list because of several complexities involved. For instance, this list do not include food and beverage, electricity distribution, and portable water businesses because the profits gained are from the sales made to the related business setups (Shepherd, 2017). As such, the eligible activities became priority choices for most people. There were some imbalances in the industries given that some of the business activities no longer operate.

Another unintended impact were the conflicts that arose between the business owners and those implementing the law. The leading cause of these differences is the fact that the government did not clarify the types of activities eligible for the program. The idea that one can start a company and run it for a while only to know that it is ineligible for the deductions is very unsettling for any business.

Recommended Modifications and Their Implications

            Even though the domestic manufacturing deduction was repealed and replaced with the qualified production activities income, there are still some controversies surrounding the law. The main aim of the program is to encourage local production companies. However, the government should clarify further on the businesses that fall under qualified production activities. This move will reduce the conflicts that happen between IRS and the companies. Reducing these uncertainties will give the entrepreneurs a clear mind as they jump into their preferred sectors. They will also be able to explore other activities that were not clear before which is positive for the economy. Less disruption in the country’s economy will lead to more revenue generation.

The Probability of Passage

            There are high chances of having these changes passed to law because their objective is to make the current program more effective. Therefore, introducing the changes will not be too costly, but they will have a lot of positive impacts. The expected increase in the government’s revenue with little to no additional expenses will be the primary motivating factor behind its passage.

Conclusion

            The use of tax incentives may have positive or no effect at all depending on their implementation. The United States has many tax incentives available for both residential and business purposes. The energy tax credit, for instance, can be enjoyed by all citizens provided they apply energy-efficient processes that make them eligible for the program. Whether some of these incentives can attract investments depends on how appealing it is to the investors. For example, the domestic manufacturing deduction was not entirely effective because there was a lack of clarity on the qualified activities. Therefore, the government should consider either amending or doing away with some of the ineffective tax programs to free up some of the revenue.

References

Abeler, J., &Jäger, S. (2015). Complex tax incentives. American Economic Journal: Economic Policy, 7(3), 1-28.

Borenstein, S., & Davis, L. W. (2016). The distributional effects of US clean energy tax credits. Tax Policy and the Economy, 30(1), 191-234.

Comello, S., &Reichelstein, S. (2016). The US investment tax credit for solar energy: Alternatives to the anticipated 2017 step-down. Renewable and Sustainable Energy Reviews, 55, 591-602.

Sammartino, F., & Rueben, K. (2016). Revisiting the State and Local Tax Deduction. Washington, DC: Tax Policy Center. http://www. taxpolicycenter. org/publications/revisiting-state-and-local-tax-deduction.

Shephard, A. (2017). Equilibrium search and tax credit reform. International Economic Review, 58(4), 1047-1088.

 

 
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