In Search of Elusive Growth: Making the Most of R&D Tax Incentives

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Today’s post is from Andrew Wyckoff, head of the Directorate for Science, Technology and Industry (STI) at the OECD. A version of this article is also being published by the Huffington Post.

Finding new sources of growth right now is tough. And in a time of rising inequality, to do so equitably and fairly is even tougher.  Innovation – which fosters competitiveness, productivity, and job creation – can help, but with budgets stretched to the limit how can governments boost innovation in their economies?

Tax incentives for business R&D is a good place to start. As of 2011, 27 of the OECD’s 34 members provided tax incentives to support business R&D – more than double the number in 1995. By 2011, over a third of all public support for business R&D in OECD countries came through tax incentives – a share that jumps to more than half when the US – with its large direct procurement of defence R&D – is excluded. Other economies – including Brazil, China, India, Singapore and South Africa – have also instituted new tax provisions to stimulate investment in R&D.

As they have proliferated, R&D tax incentives have become more generous. Over the period 2006-2011, about half of the 23 countries for which complete data are available increased their generosity, with R&D tax support rising by almost 25% in some countries.  This probably underestimates the shift towards greater generosity because the economic crisis caused a decline in both profits (and hence taxes) and R&D.   This growing popularity of R&D tax incentives as a policy instrument is due to a variety of reasons including being exempt from EU and WTO “state aid” rules, and the fact that tax expenditures tend to be “off budget, ” meaning they  escape the scrutiny that applies to direct expenditures.

A new OECD report shows that in a relatively short period of time, R&D tax incentives have become among the most widely used policy instruments to promote innovation. Some have asked “is this too much of a good thing?” and in this era of tight public budgets “are governments (and citizens) getting value for money?”  The answer depends on the exact design of the R&D tax incentive.

Most firms engaging in R&D are multinationals that can use cross-border tax planning strategies that result in tax relief that may exceed what was originally intended. This in turn may cause an unlevel playing field vis-à-vis purely domestic firms that do not benefit from these same tax planning strategies. This may also disadvantage young firms that have been the disproportionate source of net job growth and tend to be the origin of radical new innovations that spur growth.

Evidence from 15 OECD countries over 2001-11 suggests that young businesses, many of which are among the most innovative, play a crucial role in employment creation regardless of their size. Over this period, young firms (less than or equal to five years of age) accounted for almost 20% of total (non-financial) business sector employment but generated about 50% of all new jobs created. And, during the economic crisis the majority of jobs destroyed generally reflected the downsizing of large mature businesses, while most job creation was due to young enterprises.

Some will argue that R&D tax incentives are preferable to direct support policies so as to avoid picking winners.  But this isn’t an either/or situation. A mix of incentives could be the smartest path forward. Recent OECD analysis shows that well-designed direct support measures – contracts, grants and awards for mission-oriented R&D – may be more effective in stimulating R&D than previously thought, particularly for young firms that lack upfront funds.   Direct support that is non-automatic and based on competitive, objective and transparent criteria can stimulate innovation.

It’s the policy package that matters. Tax incentives should be designed to better meet the needs of domestic companies and young, innovative companies that do not benefit from cross-border tax planning opportunities. There should be a balance between indirect support for business R&D (tax incentives) and direct support measures to foster innovation. And governments should ensure that R&D tax incentive policies provide value for money.

Do this and growth might be a bit less elusive than we think.

Useful links

Andrew Wyckoff talks about innovation, growth and jobs:

OECD work on innovation

What is BEPS and how can you stop it?

Taxes can spur and guide innovation

[This text was written by Jeffrey Owens, director of OECD’s Centre for Tax Policy and Administration]

Innovation is fundamental to long-term prosperity – it drives growth and makes economies more nimble, dynamic and productive. The tax system can be a powerful policy instrument for spurring this. Tax measures can stimulate innovation; taxes on pollutants can guide innovation demand towards meeting environmental challenges.


Big variations in R&D spending

People often think about innovation in terms of research and development – R&D. The Factblog has already compared R&D expenditure as a percentage of GDP, so this time we’re looking at R&D expenditure per capita – in other words, how much do countries spend per person on R&D. Again, differences between countries are stark, with Israel and Sweden spending 14 times more per year per person than Turkey. Countries like United Kingdom or France are slightly below the OECD average.

But R&D is only one part of the innovation story. (more…)

What a tangled web we weave!

If they added a TV screen and electronic stylus, they could sell dozens of these

If it wasn’t for Ed Roberts, who died today aged 68, blogs probably wouldn’t exist. After selling electronics kits to model rocket builders, Ed went on to design and build the Altair 8800 for MITS, a company based in his garage. The 8800 was promoted on the front page of the January 1975 issue of Popular Electronics as the “World’s first minicomputer kit to rival commercial models”.

The young Bill Gates and Paul Allen read the magazine and contacted Roberts with an offer to write software for his machine. When he accepted, they moved to Albuquerque, where MITS was located, and founded a company known as Micro-Soft. Personal computing was born, and Ed Roberts is widely hailed as its father.

It wasn’t supposed to be like that. You may have seen some variant of the forecast attributed to IBM founder Thomas Watson that the global market for computers could reach five or six. And the history of technology is full of stories of predictions that turned out to be hilariously, or tragically, wrong. There are two basic mistakes.

The first is to imagine that the future is simply an extrapolation of the present. OECD Insights: International Trade tells how in the early 1980s, AT&T hired the consultancy firm McKinsey to study cellular telephony. McKinsey estimated that by the year 2000, there could be 900 000 cell phones worldwide. Today, twice that many handsets are sold in a week. McKinsey would have been right if phones and services had stayed much as they were at the time. In 1985, a mobile phone weighed 20kg and in the UK it cost the equivalent of 320 Euros at today’s prices to rent for three months.

The second mistake is to fail to see potential connections. Telephony and computing had been around for a long time before they got together to make the Internet. 

In these cases we’re talking about technology, where companies are actively seeking to transform ideas into profits. In science, the issues are a bit different, but some of the poor thinking underlying technology forecasts is often at work.

Scientific research is routinely accused of being a waste of money. Partly, this is due to media stories like the formula for a perfect wife. At a more fundamental level, though, many people, including politicians who decide on R&D budgets, don’t understand how science works.

Often, we hear that it should be “useful”. But how do you know in advance where research might lead and what its uses could be? Take ornithology. You could make a convincing case that bird watching is a fascinating hobby, but governments shouldn’t be paying people to do it. It doesn’t have much economic value, except as a minor tourist attraction. Then along comes avian influenza, and the possibility that some national poultry industries could be wiped out, or that the virus could even mutate and infect humans. Suddenly, migration patterns, nesting habits and the like become vital pieces of information.

The same is true about another piece of news that hit the headlines this week. Researchers working in Italy discovered that toads may predict earthquakes. The scientists were studying breeding behaviour. They weren’t looking for anything remotely to do with seismology, but the finding could turn out to be a “useful” contribution to predicting Earth tremors.

One of the most positive aspects of globalisation is that connections that once would have been impractical or unimaginable are commonplace. Not just goods, but ideas and knowledge flow quickly around the world and we’re no longer surprised by Japanese whisky or Texan basmati rice or Iranian Lacanians. But we would be surprised if we knew what new combinations the future has in store.

Useful links

OECD science and innovation web site