Selective eligibility for corporate tax credits should produce broader public benefits

Not all publicly traded companies use savings from tax cuts the same way, NBER researchers James Cloyne, Ezgi Kurt, and Paolo Surico report in “Who gains from Corporate Tax Cuts?  While changes in marginal tax rates and investment tax credits (ITC) can have significant effects on the behavior of publicly traded C-corporations, manufacturers and goods producers are much more likely to recirculate the savings into additional capital expenditure and employment than firms in the service sector.  Publicly traded service sector companies typically use the proceeds from a tax cut to increase dividends to current investors in the firms.

 The researchers found that a cut in the marginal tax rate can increase capital expenditure. An increase in ITC also increases capital expenditures, but at a lower rate than a cut in the marginal tax rate. In addition, the paper discusses findings from previous research that indicated tax policy can impact macroeconomic trends in GDP, investment, and employment rates. Further, these macroeconomic impacts can affect microeconomic trends, such as firm-level capital and labor demand when viewed in the aggregate. Distinguishing types of firms as either goods producers or services providers revealed the differences in uses of the benefits – and the difference in the tax cuts benefits for the public good.

Considering the macro and microeconomic impacts that changes in tax policy can have, it is critical to note global tax policy trends. The effort for stronger R&D tax credit policy seen in the U.S. is part of a larger trend. In recent years, there has been an increase in tax incentives aimed at innovation and R&D, according to two working papers from the Organization for Economic Cooperation and Development (OECD).

One of the OECD working papers, “Costs and uptake of income-based tax Incentives for R&D and innovation,” found that income-based tax incentives have become increasingly widespread among OECD countries. As of 2021, 22 of 38 OECD countries and 17 of 27 EU countries offered income-based tax incentives, typically in combination with expenditure-based tax incentives. Twenty-one OECD and 15 EU countries offered both forms of tax support in 2021. Using data from seven of 23 countries, the authors found that small and medium-sized enterprises (SMEs) made up the majority of recipients of income based-tax relief, but the income-based tax benefits were more common amongst large firms. The authors also found that there is no clear pattern across industries, just across firm sizes.

Source: OECD, Appelt et al, “Cost and uptake of income-based tax incentives for R&D and innovation”

Further, the working paper finds that there are a number of “conceptual and practical challenges,” when measuring the extent of which income-based tax incentives provided by governments support R&D and innovation and these challenges are especially difficult when comparing international governments. The authors also measure the financial cost that the government undergoes in providing tax relief for R&D and innovation through forgone tax revenue. The forgone tax revenue by governments is estimated to be small, as in 2019, when 23 of 29 countries offered income-based tax relief and the magnitude of these preliminary estimates appeared to be, “less than 0.01% of GDP in 12 out of 23 countries.”

The second OECD working paper, “Design features of income-based tax incentives for R&D and innovation,” has similar findings, specifically that in recent years, there has been an increase of tax incentives aimed at improving innovation. The paper also notes that without government intervention, businesses tend to underinvest in R&D and innovation activities, “relative to a level that is socially optimal.” In addition to this, governments “seek to maintain a globally competitive environment for businesses to retain and encourage commercialization of the underlying intellectual property (IP),” and have the right to tax income from the IP. To adequately compare countries and their tax policies, the paper cites next steps to include, “developing indicators” to facilitate this comparison of income-based tax incentives and subsidies.