New Report on R&D Tax Incentives Shows Best Practices

Earlier this year the European Commission released a substantial report on R&D tax credits throughout the EU and several other OECD countries including the United States and Japan. R&D tax credits have been widely adopted across the developed world since the United States introduced the Research and Experimentation tax credit in 1981: only two countries in the EU do not have tax policies intended to encourage R&D.

The report is a thorough meta-study looking at the existing economics literature and available data on R&D-focused tax policy, including the impact of R&D tax policies on R&D expenditure, innovation, employment, productivity, and other factors. It also covers the literature on how corporate tax policy can affect the location of R&D and patents. Finally, the report examines the details of various tax policies and benchmarking them based on what they determine to be best practices.

The report makes a number of facts clear. First, despite a broad range of findings, “the vast majority” of studies surveyed show that R&D tax incentives are effective, with the most recent (and rigorous) studies finding that a 10% in the user cost of R&D results in a 1% to 6% increase in R&D spending (though other studies have found a significantly higher increase).

Second, the report offers a useful guide for policymakers, explaining which properties of R&D tax incentives are best grounded in theory and evidence. The report’s recommendations for best practices are based around the scope (whether the R&D tax incentives are input related, volume-based instead of incremental, the newness of the research), the targeting (should be location-neutral, firm-nationality-neutral, not targeted at specific firm sizes but targeted at younger firms, technology-neutral, etc…) and the general organization (short decision turnaround times, efficient, evaluated, and stable) of the R&D tax incentives.

There are some good lessons here for U.S. policymakers: helping younger firms take advantage of the credit is important and has been a fixture of recent proposals for renewing the credit; the credit should also remain industry and size agnostic. The report also highlights one of the biggest problems with the U.S. credit: permanence. The U.S. credit has been renewed every few years in its more than 30-year existence, and the uncertainty of the policy makes investment in R&D unnecessarily risky for businesses.

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