Research finds young innovation-centered firms operating at a loss realize one-third less value from the federal R&D tax credit than the national average. Federal support for business R&D in the United States relies heavily on tax incentives. The federal R&D tax credit and deduction together provide far more support for private-sector research than direct federal funding programs, making them one of the government’s primary tools for encouraging innovation. How these incentives work matters to policymakers and economic development practitioners, because they can shape which firms have enough cash to invest in research, commercialize new technologies, and grow. But the value of an R&D tax incentive on paper is not always what the firms actually receive. A recent NBER working paper by Brandon Pecoraro and colleagues examines this gap and finds that the firms often viewed as key drivers of innovation frequently realize much less benefit from R&D tax incentives than statutory provisions would suggest.
The authors use confidential IRS corporate tax return data to produce what they describe as the first direct estimates of the realized present value of federal R&D tax benefits. Their analysis follows a panel of more than 22,000 C-corporations between 2010 and 2017, tracking R&D expenditures made from 2012 through 2016 and measuring how firms ultimately use the deductions and credits generated by those investments. Rather than simply calculating the value of incentives specified in the tax code, the researchers follow the actual utilization of tax benefits over time, including deductions and credits that must be carried forward because firms do not have sufficient taxable income or tax liability to use them immediately. That detail matters because tax benefits are not used in a simple first-in, first-out way. Rules for accounting for net operating losses and credits affect when the benefit can be used. In other words, the headline subsidy overstates what many companies receive.
That difference between the statutory value of R&D tax incentives and the benefits firms realize is substantial. On average, firms generated approximately $0.41 in statutory tax benefits for every dollar invested in R&D, but the realized present value of those benefits was only $0.36 per dollar. The gap reflects the fact that many firms cannot use deductions and credits immediately and must wait years before realizing their full value, if they realize it at all.
The paper examines how these outcomes vary across different types of firms. Older and larger firms generally realize most of the value of R&D tax incentives quickly because they have sufficient taxable income. Young and small companies are considerably more likely to operate at a loss and often spend several consecutive years without sufficient taxable income to take advantage of available tax benefits. These firms tend to devote a larger share of their expenses to R&D than older, more established companies. The authors estimate that young, small firms operating at a loss realize only about $0.23 in present-value tax benefits for every dollar of R&D spending, roughly 44% below the statutory value. In effect, the firms making the largest bets on innovation are often the least able to capture the full value of the incentives intended to encourage it.
One especially useful part of the paper is its distinction between deductions and credits. Most firms can use R&D deductions relatively quickly, with approximately 97% of their value realized in the year they are generated. Credits are a different story. Because the federal R&D credit is nonrefundable and subject to limitations tied to tax liability, only about 56% of credit value is realized immediately. Many credits are delayed for years and, in some cases, may expire unused.
For economic development policy, the takeaway is fairly practical: the same incentive does not work the same way for every firm. The effective subsidy varies substantially based on a firm’s age, size, and profitability. This has particular significance for technology-based economic development strategies that emphasize startup formation, university spinouts, and the growth of young innovative firms. A tax incentive designed to stimulate innovation may disproportionately benefit established firms rather than companies still years away from profitability.
The paper also directly addresses debates over whether to make R&D tax credits refundable or to create alternative mechanisms that allow young firms to receive benefits before becoming profitable. Refundability could substantially increase the value of incentives for startups and other firms with limited tax liability by converting delayed benefits into immediate resources that can support additional R&D investment. However, the authors identify an important policy tradeoff: while small, young firms experience the greatest increase in incentive value from refundability, large firms account for the overwhelming majority of R&D credit claims. Consequently, a broad refundability policy could create substantial fiscal costs while directing many of those costs toward larger corporations that already realize most of the available benefits.
For economic development organizations, the message is straightforward: the design of innovation incentives matters, not just their size. If federal R&D tax policy is meant to support early-stage innovation, then policymakers need to ask whether startups and young technology firms can actually use the benefits being offered. A larger credit on paper does little for a company without the taxable income to claim it. The findings suggest that policymakers may want to consider targeted approaches, such as limited refundability or other mechanisms designed for firms with little current tax liability.