States Can Preserve Corporate Tax Revenue Without Penalizing R&D 362

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Some state lawmakers are considering decoupling from the business expensing provisions in the One Big Beautiful Bill Act (OBBBA) to prevent what they fear will be an erosion of corporate income tax (CIT) revenue. However, this concern is largely unwarranted given the substantial expansion of the state corporate tax base since 2017, and because decoupling from Research & Experimentation (R&E) expensing would undermine pro-growth policy.

📈 Corporate Tax Base Growth: A State Windfall

States have received a significant, sustained benefit from the federal Tax Cuts and Jobs Act (TCJA) of 2017 without having to implement the offsetting corporate rate cuts that the federal government adopted.

  • Substantial Base Expansion: Since the TCJA was enacted, the federal CIT base has expanded dramatically. Revenue collected per percentage point of the corporate tax rate has nearly doubled, rising from an average of $10.88 billion (2000–2016) to $19.30 billion (2017–present) in real terms.
  • Post-OBBBA Projections Remain High: Even with the new expensing provisions in the OBBBA, the corporate tax is still projected to raise approximately $16.94 billion per rate percentage point—significantly higher than the pre-TCJA trajectory.
  • Frontloaded Costs: The “cost” to state revenue from conforming to the OBBBA is heavily frontloaded (occurring in the first year). The gap between OBBBA revenue projections and previous baseline projections shrinks considerably in subsequent years.

The data shows that state corporate income tax collections are well above historical levels, meaning states can afford to conform to the federal expensing policies restored by the OBBBA.

🔬 The Danger of Decoupling from R&E Expensing

The OBBBA restores four key business expensing provisions, two of which draw the most attention: first-year expensing for business machinery and equipment (M&E) under $\S 168(\text{k})$ and first-year expensing for research and experimentation (R&E) under $\S 174$.

The R&E Expensing Precedent

  • Decoupling is an Abandonment of Historical Policy: From 1954 to 2022, corporations were universally allowed to deduct R&E expenditures in the year they were incurred. Every state with a corporate income tax historically conformed to this $\S 174$ policy.
  • Temporary Amortization was a “Gimmick”: The requirement for five-year amortization of R&E costs, which took effect in 2022 due to the TCJA, was widely seen as a budgeting maneuver not intended to be permanent. States actually received a temporary windfall during the three and a half years of amortization (2022 to the OBBBA’s enactment) because deductions were spread out.
  • Penalizing Investment: Requiring amortization rather than immediate expensing creates a tax bias against R&D investment. This is because the present value of deductions is eroded by inflation and the time value of money, which disadvantages businesses and runs counter to most policymakers’ stated goals of promoting innovation.
  • Broad vs. Targeted Incentives: The $\S 174$ immediate expensing is available to all companies with net income, providing a broad, pro-growth incentive. This contrasts with targeted R&D tax credits, which often only benefit large, incumbent firms.

Conclusion: States do not need to abandon the nearly seven-decade-old, pro-growth policy of R&E expensing to maintain strong corporate tax revenue. The current tax base is robust enough to absorb the short-term, frontloaded costs of conformity. Decoupling from $\S 174$ would introduce a counterproductive penalty on research and development.

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