What Does the R&D Tax Credit Do, Exactly?

I was going to write an Atlantic Flashcard on the R&D tax credit, which the president has proposed to expand and make permanent. But Ezra Klein beat me to the explanatory punch:

The Research and Development Tax Credit is a tax provision that gives companies that invest in research in the United States a credit on their taxes. It was put in place under the Reagan administration in 1982, because there was a feeling we weren't competing that well against the Japanese and the Germans. There are two versions, one of them, the simplified version, is more often used, and it's a 14 percent deduction above 50 percent of your research costs -- so more or less a 7 percent credit in net.

Economists favor the credit because there's a lot of evidence that companies don't capture all of the benefits from their research. Those benefits spill over to other companies and industries. So absence a credit, companies will underinvest in research. And the credit also affects where companies choose to do their research. We are now 17th in R&D credit generosity compared to the 30 OECD nations. A decade ago we were number one.

Read the full interview at Klein's blog.