Minnesota's R&D tax credit is popular with business and lawmakers. But does it work?

The 2017 Legislature is considering a trio of bills to expand state tax incentives for corporate research and development, with advocates arguing that Minnesota has fallen behind in the national competition for high-tech industry.

Yet Minnesota has never formally evaluated whether the state R & D tax credit works — or even disclosed which companies benefit.

The bills are being discussed even as the state's legislative auditor prepares to release a new report on the tax provision, which will for the first time examine the effectiveness of a subsidy that cost taxpayers an estimated $64.8 million last year.

The report, due out this week, is the first under a 2015 law requiring Jim Nobles' office to evaluate at least one state incentive for economic development every year. His staff drew up a list of 32 such programs affecting the state's General Fund.

The corporate R & D tax credit is popular with executives in the high-tech and medical device industries, who say it helps Minnesota compete with other states. But some leaders in the small-business community say it's tilted in favor of big corporations and against small entrepreneurs.

The credit, enacted in 1981, allows companies to reduce the amount of state corporate income tax they pay; some of what they spend on qualifying research conducted in Minnesota is subtracted from taxes owed. Minnesota was the first state to create its own R & D tax break, to pair with the similar federal credit.

In fiscal 2016 the credit erased about 3.5 percent of Minnesota's corporate tax haul.

The credit was designed to help Minnesota create and retain high-paying jobs, and there is some evidence to support the theory. Daniel Wilson, an economist at the San Francisco Federal Reserve Bank, studied the state credits and concluded that creating or expanding a state's R & D tax credit "led to a significant increase in R & D in that state over subsequent years."

He added, however, that nearly all of that increase "came from R & D activity relocating ... from other states.

"Nationally," Wilson said, "it is a zero-sum game."

Shaye Mandle, head of Minnesota's Medical Alley Association, said it's high time the state expanded the R & D provision because other states have such generous credits that Minnesota's "not in the game."

At a House Tax Committee hearing on Tuesday, Mandle passed around Medtronic's bullet-sized silver "Micra" pacemaker, billed as the world's smallest pacemaker, and a Boston Scientific "Watchman" implant, which resembles a white parachute about the size of a lifesaver that helps prevent strokes.

"Both of these products were almost entirely developed here in Minnesota," Mandle told lawmakers. "The R & D tax credit is directly related to supporting the activity that produces these lifesaving therapies."

Margaret Anderson Kelliher, a former legislative leader and head of the Minnesota High Tech Association, says the tax credit is "one of those markers of a strong robust innovation economy."

"We are falling behind," she said in an interview.

But detractors fault Minnesota for the lack of transparency surrounding its R & D credit. Good Jobs First, a Washington, D.C. nonprofit that tracks corporate subsidies, gives Minnesota poor marks in part because the state doesn't disclose who gets the tax break and the amount they claim.

In a number of other states, such as Massachusetts and North Carolina, that information is public.

In its current form, the provision allows Minnesota companies to claim a credit for the first 10 percent of qualifying expenses, up to $2 million, and for 2.5 percent of expenses beyond that. A trio of bills introduced in the House would:

• Extend the credit to sole proprietorships.

• Increase the second tier from 2.5 percent to 4-6 percent.

• Make the credit "refundable" again, so that early-stage start-ups can use the provision and get a check from the state, even if they are losing money and so not paying corporate income tax.

• Simplify the required calculations.

The bills were introduced last year, too, but didn't make it into law.

Rep. Sarah Anderson, R-Plymouth, who is spearheading the bills again, said she's not concerned about the Nobles report. It's a standard review, Anderson said, and any changes to the tax credit that need to be made will be made.

Apart from transparency, some business leaders also complain that Minnesota's credit is dominated by corporate heavyweights such as Medtronic and 3M. The big companies are loathe to discuss the benefit, and Medtronic would only confirm that it does use it.

Measuring the tax credit's effectiveness is nearly impossible, since the state Revenue Department considers recipient names and amounts to be private tax information. The legislative auditor's office got special access to that information for its investigation.

"They make billions of dollars, and here I am struggling along and I can't get it," said Mark Gross, founder of Formacoat LLC, a medical device contract manufacturer in Savage with 15 employees and about $2 million in annual sales.

Gross is currently organized as sole proprietor, and has testified four times at the Capitol in recent years to expand the credit so he can use it. Now that Formacoat is profitable, he said, he plans to convert it to an S Corporation, a different way of incorporating a business, so he can take advantage of the tax credit.

Some small manufacturers shy away from the credit because they've heard that the Revenue Department uses "aggressive audit techniques," said Beth Strinden Kadoun, vice president of tax and fiscal policy for the Minnesota Chamber of Commerce. She said the key question has been what constitutes research and development, but argued that Revenue officials have been "undermining'' the program.

At Tuesday's hearing, the Revenue Department's tax policy manager asked to delay the agency's testimony until Nobles releases his report.

Speaking of its audit practices in general, a Revenue Department spokesman told the Star Tribune that the agency "strives to apply our tax laws equally and fairly for all our customers."

"To do this, we focus our attention on bringing our customers into compliance through outreach, education, and the audit process," spokesman Ryan Brown said.

Nobles would not comment on the content of his review, but his office said Friday it will be released this Thursday at a hearing at the Capitol.

Jennifer Bjorhus • 612-673-4683