Guide Examines How to Design an R&D Tax Incentive

As a part of its Compendium of Evidence on the Effectiveness of Innovation Policy intervention, the Manchester Institute of Innovation Research released a report entitled Fiscal Incentives for Business R&D. The authors advocate how a fiscal incentive for R&D, particularly a tax credit, can be a "flexible instrument that can foster the connectivity within a national innovation system."

When considering the construction or retooling of an R&D tax incentive, policymakers must consider the general purpose of the incentive, who it is meant to benefit and target, what to do with unused claims and other aspects of incentive's design. The authors created a typology based on former and current innovation policies in various countries throughout the world, particularly in Europe. The report outlines the various design features policymakers must consider when designing and implementing an R&D tax credit.

• The type of tax incentive: There are currently four types of incentives in place throughout the world including accelerated depreciation schemes, special R&D allowances, special exemptions of wages and/or social taxes, and tax credits that are currently the most widespread. The report also highlighted a new R&D incentive implemented in some European nations known as Patent Box.
• The basis of calculation for tax credits: This aspect relates particularly to tax credits and determines how the funding source calculates the distribution whether it is volume-based scheme in which all eligible R&D funds are considered or an incremental scheme in which only the increase in R&D expenditure is considered.
• The definition of eligible operations: Several different countries are trying to implement one definition for what constitutes R&D to level the playing field, including the calculation of overheads.
• The generosity of the tax credit: The funding source has to determine how substantial the award will be and whether it will be determined based on a percentage measure, a maximum amount or a combination of both.
• The subjects of the R&D incentive: A critical consideration that can affect the success of the incentive and the overall innovation policy is the determination of who is eligible to receive the tax credit. Incentives can be geared towards SMEs, recently created firms, industry-university collaborations, certain fields, geographical locations, or other targeted groups.
• The consumption of tax credits: Policymakers must consider the parameters surrounding the consumption of tax credits by firms such as whether they are applied only to expenditures within the same fiscal year, or if they can be carried forward or backward.
• The duration of the measure: As with any policy, one must consider the duration of the measure and how often it is approached for renewal in order to allow for flexibility without compromising the effectiveness of the incentive.

According to the report, R&D tax incentives have been widely applied by governments in various nations over the past 40 years. The U.S. R&D Tax Credit has been in place for several decades, growing more and more generous over the years in addition to expanding qualifying activities. And even in this contentious election, both candidates agree on many aspects of the future of U.S. innovation policy and support making the R&D tax credit permanent.

Read the complete Compendium of Evidence on Innovation Policy...