Although most studies find that R&D tax incentives promote R&D, there is little consensus on the extent of this effect.
A recent firm-level analysis from the United Kingdom finds some of the strongest evidence to date on the effectiveness of R&D tax credits in incentivizing innovation. At the same time, however, other studies suggest other elements of a national economy such as education and infrastructure may be more important.
In Do Tax Incentives for Research Increase Firm Innovation? An RD Design for R&D, Antoine Dechezleprêtre, Elias Einiö, Ralf Martin, Kieu-Trang Nguyen, and John Van Reenen – four researchers from the London School of Economics – analyze a 2008 policy that changed the threshold for what size businesses counted as a small and medium-enterprise (SME) for the UK R&D Tax Credit system.
The authors utilize a “regression discontinuity design” to best view the impacts of the new tax threshold. Using confidential access to firm tax records and accounts from more than two million businesses, the authors are able to assess how firms changed their approach to R&D before and after the change went into place.
They find that expenditures on R&D roughly doubled and patenting increased by approximately 60 percent. Additionally, the authors find that firms receiving a larger incentive to perform R&D through the policy change grew in both sales revenue and in number of jobs.
No other policies were implemented around the threshold analyzed, the authors argue, so the large jumps in both R&D expenditures and in patenting were likely due to the new policy. While increases in R&D expenditures are noteworthy, the authors consider the impact on innovation and patenting particularly important.
One concern with R&D tax credits, as mentioned by the authors, is that some firms may re-label other activities that were not previously considered R&D as a means to take advantage of the credits. While this would, perhaps, explain some of the variation in R&D expenditures, there is no incentive to do this for patenting.
Furthermore, the authors find evidence that the quality of patents were not negatively impacted; firms increased the rate at which they applied for both EU-wide patents and UK-only patents, while the citation rate per patent did not decline.
The authors find that a 10 percent fall in the price of R&D generates an approximately 26 percent increase in the volume of R&D, an amount that is larger than that found in previous studies.
The authors suggest that one potential reason for this is that most studies focus on large firms or on aggregate amounts that are heavily influenced by large firms, while the UK policy analyzed by the authors focuses explicitly on SMEs.
Given that smaller firms are more likely to face cash constraints to fund their innovative endeavors, they were more responsive to the policy that effectively made these activities more affordable.
In the newly released book, Rethinking Investment Incentives: Trends and Policy Options, the fourth chapter entitled Use of Investment Incentives: The Cases of R&D Related Incentives and International Investment Agreements and written by Christian Bellak and Markus Leibrecht, highlights the economic case for investment incentives, especially around topics such as research and development.
For the rest of Dworin’s report, click here.