To encourage business R&D: grants or tax credits?

November 14, 2019
By: Mark Skinner

The importance of business and industry R&D investment for competitiveness and economic growth is a well-entrenched dictum of national and state innovation policy across most of the developed world. Approaches for incentivizing increased research expenditures fall into two broad categories, direct grants and subsidies to offset R&D costs or R&D tax credits companies may take post-investment for research expenditures. Direct subsidies or competitively awarded grant programs optimally target specific activities, desired outcomes and performance milestones (e.g., the SBIR/STTR programs). A new paper looks at which approach – direct subsidies or R&D tax credits – actually works better for achieving at least one of the stated policy goals: increasing competitive, private R&D investment?

A research paper presenting analysis of 17 years of data from 36 member nations and 11 partner economies of the Organisation for Economic Co-operation and Development (OECD) draws conclusions that might surprise tax credit advocates. The authors, Silvia Appelt, Fernando Galindo-Rueda and Ana Cinta Gonzalez Cabral, state:

“Across the board, [the study’s] results imply that the additionality [or desired public policy benefit] of direct support might be on average slightly higher than for tax incentives. This finding, consistent with the literature, can be explained by the fact that most R&D tax incentives are provided on a non-discretionary basis.”  [Note: later in the report, the authors point out the difference is not statistically significantly higher.]

In other words, not all R&D may be created equal with regard to public value or use. As a result, the cost to the public in forgone revenue to support other necessary public sector expenses that results from a company taking the R&D tax credit may not be necessarily commensurate with the company’s R&D expenditures. The authors suggest, but are not prepared to say this particular study provides the assessment required to recommend, that R&D tax credits, if used, may be most effective when applied in a non-discretionary fashion to those R&D expenditures which are expected to result in the greatest additionality.

Direct subsidy programs to support business R&D may not be without their own complications, implementation challenges and drawbacks, the authors caution. Higher administrative costs for government and higher compliance costs for firms are two examples. As a result, the authors offer a nuanced conclusion suggesting, “An optimal policy mix is likely to require a combination of discretionary and non-discretionary support elements.”

Perhaps of more value for policy makers interested in the efficacy of policy interventions to encourage business R&D investment is the opportunity to work directly with the publicly accessible OECD R&D Tax Incentives Database on which the paper is based. Users will be able to access first-ever, consistent time-series estimates of the cost of government tax relief for business R&D investment (foregone tax revenue and refunded amounts) for 2000 through 2016.  Additionally, the database contains the new B-Index, presenting implied marginal R&D tax subsidy rates and profitability estimates for both SMEs and large firms from 2000 through 2018.

r&d, r&d tax credits