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Efficiency of R&D tax incentives in OECD economies

Effectiveness of R&D tax incentives in OECD economies

Silvia Appelt, Matej Bajgar, Chiara Criscuolo, Fernando Galindo-Rueda

Tax incentives have ended up being the primary policy tool that governments utilize to motivate companies to invest in research and development. This column presents the outcomes of a brand-new analysis of firm-level records in 20 OECD countries, which recommends that, in general, R&D tax rewards are effective in improving company R&D but their efficiency varies greatly throughout companies of different sizes and across countries. Tax incentives are likewise much better fit for supporting R&D tasks better to the market while direct government funding– such as through grants and R&D procurement– is more conducive to research that may not instantly lead to brand-new products or services.

R&D tax rewards have actually overcome mechanisms for direct funding of service R&D as the biggest channel through which OECD governments financially support R&D financial investment by the organization sector. In 2017, R&D tax rewards accounted for around 0.10% of GDP and 55% of total (direct and tax) government support in the OECD area.

Tax incentives are created to promote R&D activity by reducing the user expense of R&D to companies that engage in this kind of activity. Unlike direct funding, which involves discretionary (and possibly pricey) choices on the part of governments on which R&D tasks and companies to support, the majority of R&D tax rewards are market-based instruments that offer a more broad-based assistance– adhering to state aid and global competitors guidelines– with the pledge of lower administrative and compliance costs. In 2020, 32 out of 37 OECD nations use R&D tax incentive assistance at the main government level.

R&D tax incentives been available in many shapes and sizes. In some countries (such as the Czech Republic and Belgium), corporate R&D entertainers get the very same rate of R&D tax aid, irrespective of their size or level of R&D spend, as no upper ceilings or limits apply that would restrict the value of R&D tax relief or certifying R&D expenditure The same is true for countries that impose such constraints but those are efficiently not binding or only so for a handful of companies (such as France).

If nations support R&D just approximately a particular ceiling, be it in-house (as in Chile, Norway, Sweden) or outsourced R&D (as in Austria), and if this ceiling is adequately low, the rate of tax assistance is efficiently greater for firms that perform less R&D, which are on average also of smaller sized size.

Other nations use a preferential tax treatment to little and medium enterprises (e.g. Australia, Canada and Japan) or start-ups (e.g. the Netherlands and Portugal) in type of boosted tax credit or allowance rates. Targeted rates might also request specific kinds of research (e.g. fundamental and energy research study, collaborative R&D).

Despite the general pattern towards volume-based plans that subsidise companies’ R&D from the very first euro, a couple of countries support the increment in R&D over past levels, either alone (e.g. Italy, the US) or in combination with a volume-based tax relief element (e.g. Czech Republic, Japan, Portugal, Spain).

Lastly, distinctions also exist in the method federal governments define certifying R&D expenditure or deal with outsourced R&D and R&D- related capital investments in addition to in the arrangements that use to loss-making firms (e.g. carryovers or a ‘cheque’ from the tax authorities).

All these style includes combined cause substantial variation in R&D tax subsidy rates throughout countries and kinds of companies, from around no (i.e. no R&D tax credits, for example, Finland and Germany) approximately around 40 cents per euro of R&D spend in France and Portugal.

To date, empirical research studies examining the results of R&D tax rewards have either focused on private countries (e.g. Hall 1993, Agrawal et al 2019, Dechezleprêtre et al. 2016) or explored changes in aggregate R&D performance across countries (e.g. Bloom et al 2002, Thomson 2017).

Country-specific research studies provide crucial evidence but the findings for a specific country, duration and classification of firms can not always be generalised to other contexts, which impacts their external validity. Aggregate (cross-country) studies, in turn, can state little about how R&D tax rewards affect firms of different size, new and existing R&D performers or different kinds of R&D expense.

In recent work (Appelt et al. 2020), we combine the much deeper granularity and detail of firm-level analysis with the abundant variation and stronger generalisability of cross-country research studies. We team up with national specialists in 20 OECD countries (Australia, Austria, Belgium, Canada, Chile, the Czech Republic, France, Germany, Hungary, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Spain, Sweden, Switzerland and the UK; work is under way to include the US).

These experts use a harmonised analytical code to confidential microdata used to produce official R&D stats. These information, covering the years 2000-2017, would be otherwise impossible to access, link and analyse directly. This distributed technique provides us a special chance to explore the impact of R&D tax incentives and direct financing on service R&D investment, both throughout and within major OECD economies.

What do we find out?

R&D tax rewards work in promoting business R&D

Overall, in line with existing proof, our research study verifies that R&D tax rewards appear to have a considerable influence on company R&D. Across countries, industries and firm of various size, 1 unit of R&D tax support is associated on average with around 1.4 units of R&D investment.

Utilizing administrative records on which firms really get R&D tax relief permits us to consider the truth that not all firms that remain in concept entitled for support in fact advantage. Stopping working to represent this would only enable us to approximate an ‘intent to treat’ effect and make us overestimate the costs of R&D tax rewards and underestimate their effectiveness.

The boost in R&D expenditure in reaction to tax rewards might partially show a boost in the price of R&D inputs, and specific in scientist wages (Goolsbee 1998, Haegeland and Møen 2007, Lokshin and Mohnen 2013). But we do not find any evidence of such wage results. Instead, R&D tax incentives appear to stimulate the volume of R&D inputs bought by companies that currently perform R&D and make firms more likely to start or continue investing in R&D.

More powerful impact for smaller R&D entertainers

These ‘average’ effects hide crucial variation in the efficiency of R&D tax incentives throughout different kinds of companies. A more thorough analysis of firm heterogeneity shows that a person euro of R&D tax assistance translates into over 1.4 euros of R&D for little companies with less than 50 employees, one euro of R&D for medium-sized companies with 50-249 staff members, and only about 0.4 euros of R&D for large firms with 250 staff members or more. R&D tax incentives promote current R&D expenditure– R&D labour expenses and consumables– only in the case of little and medium-sized firms, while they cause more capital R&D expense and outsourced R&D for companies of all size.

Figure 1 Result of R&D tax rewards on R&D investment by firm size and R&D expense.

Notes: The figure shows the gross incrementality ratio of R&D tax incentives– the quantity of R&D investment caused by one euro of R&D tax support. The incrementality ratios are derived from estimated elasticities of intramural R&D expenditure with regard to the B-Index, i.e. the tax-incentive element of the user expense of R&D. We run OLS regressions on observations defined by nation, market, firm size class and year, managing for industry value added and an abundant set of dummies. The hairs mark the 90% confidence period.

Importantly, the differences throughout firms of various size do not seem to originate from employment size per se, but they rather reflect differences in the initial level of R&D investment throughout companies of different size. R&D tax rewards seem to increase R&D more strongly for smaller sized firms since these companies perform less R&D usually.

These findings are relevant for the design of R&D tax incentives. Initially, they lend validation to plans that use (proportionally) higher subsidies to independent smaller sized R&D performers.

Second, they recommend that appointing favoritism based upon firms’ R&D expense might be more affordable that doing so based upon criteria such as work size. That said, the stronger impacts found for smaller R&D performers when it comes to R&D inputs do not guarantee stronger results on innovation outputs or more powerful understanding spillovers to other companies. For instance, one study discovers that the R&D performed by big firms may be more likely to generate knowledge spillovers (Blossom et al. 2013).

Horses for courses

To what degree should governments rely on R&D tax rewards vis-à-vis direct assistance measures such as R&D grants? We discover that one euro of either direct or tax assistance leads to around 1.4 euros of R&D on average. While the two kinds of support do not seem to differ in their total effectiveness, they may serve different policy objectives. R&D tax rewards appear better fit to enhance R&D that is more detailed to market applications. Its impact on experimental advancement (the D in R&D) is practically twice as big as its result on research (the R).

In contrast, direct funding seems especially important for encouraging company research, which tends to be of an applied nature however does not necessarily cause a new product or process (for example, developing brand-new molecules that might be later trialled as drugs).

Comparison across countries

The results on R&D investment can be expected to differ throughout countries offered the large variation in the style of R&D tax incentives and qualities of companies getting assistance. To approximate the impact of the R&D tax incentives within individual countries, we compare firms that begin getting tax relief with otherwise comparable firms that do not count on such assistance.

In addition, we study policy changes that impacted some businesses however left the assistance for others the same. For example, when the SkatteFUNN tax credit was presented in 2002, it only used to R&D expenditure up to a level of 4 million krone. As a result, it reduced the cost of an extra system of R&D only for firms that had R&D costs below this ceiling prior to the intro of the reward. By comparing companies listed below and above the ceiling, before and after the introduction of SkatteFUNN, we can estimate the impact of the tax credit on companies’ R&D efficiency.

We check out similar policy changes for other nations.

Figure 2 Result of R&D tax rewards on R&D investment by nation

Notes: For each country, the figure reveals the gross incrementality ratio of R&D tax incentives– the amount of R&D investment induced by one euro of R&D tax subsidy. The incrementality ratios are derived from projected impacts of intramural R&D expenditure. We run OLS regressions at the firm level, comparing companies impacted by a policy modification to those that have not been affected, prior to and after a policy change. The hairs mark the 90% self-confidence interval.

We discover that the estimated effectiveness of R&D tax rewards certainly varies significantly across countries. The amount of R&D caused by one euro of R&D tax subsidy tends to be greater for modifications in R&D tax relief provisions that target little (Australia) versus big (Japan) R&D performers or impose a ceiling on the eligible R&D expense (Norway, Sweden). This worth is higher when the analysis concentrates on outsourced R&D (Austria) and lower when R&D tax relief receivers tend to be reasonably big (e.g. France). This is consistent with the finding that the effect of R&D tax incentives tends to be bigger for smaller R&D performers.

What next?? We have actually so far examined the effects of R&D tax incentives on R&D inputs (input additionality). These effects are important since if companies did not invest more in R&D in reaction to the incentives, no subsequent impact could be expected.

However the supreme aim of R&D tax incentives is to increase development and performance growth. Whether and how they do so is what we prepare to take a look at in our future work, again in collaboration with nationwide specialists. In addition, we plan to explore even more the function that policy style plays in determining the effectiveness of R&D assistance procedures in different nations.

Referrals

Agrawal, A, C Rosell and T Simcoe (2020 ), “Tax Credits and Small Company R&D Spending”, American Economic Journal: Economic Policy 12( 2 ): 1-21.

Appelt, S, M Bajgar, C Criscuolo and F Galindo-Rueda (2020 ), “The effects of R&D tax incentives and their role in the innovation policy mix: Findings from the OECD microBeRD project, 2016-19”, OECD Science, Innovation and Industry Policy Documents, No. 92, OECD Publishing, Paris.

Bloom, Nick, Rachel Griffith, and John Van Reenen (2002 ), “Do R&D Tax Credits Work? Proof from a Panel of Countries 1979– 1997”, Journal of Public Economics 85( 1 ): 1– 31.

Blossom, N, M Schankerman and J Van Reenen (2013 ), “Identifying Innovation Spillovers and Item Market Competition”, Econometrica 81: 1347-1393.

Dechezleprêtre, A, E Einiö, R Martin, K-T Nguyen and J Van Reenen (2016 ), “Do Tax Incentives for Research Study Boost Company Innovation? An RD Design for R&D”, NBER Working Paper 22405.

Goolsbee, A (1998 ), “Does Federal Government R&D Policy Primarily Benefit Researchers and Engineers?”, American Economic Evaluation 88( 2 ): 298– 302.

Haegeland, T and J Møen (2007) “The Relationship in between the Norwegian R&D Tax Credit Plan and Other Innovation Policy Instruments”, Statistics Norway Report 2007/45.

Hall, B (1993 ), “R&D Tax Policy throughout the 1980s: Success or Failure?”, Tax Policy and the Economy 7: 1-35.

Lokshin, B and P Mohnen (2013 ), “Do R&D Tax Incentives Result In Greater Wages for R&D Employees? Evidence from The Netherlands”, Research Study Policy 42( 3 ): 823– 30.

Thomson, R (2017 ), “The Effectiveness of R&D Tax Credits”, Evaluation of Economics and Stats 99( 3 ): 544-549.

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