Firms’ R&D investments increase innovation
According to a new study, tax subsidies for research and development significantly increase innovation by firms.
According to a study by VATT senior researcher Elias Einiö together with a team of researchers from the London School of Economics, one euro of tax stimulates 1,7 euros of R&D investments. In the light of the findings, Finland’s premature termination of a tax relief experiment in 2014 may have been a mistake.
The study observed that raising additional deductions for research and development expenditure by 45 percentage points almost doubled the volume of firm innovations. The study measured innovation in terms of firms’ patenting activity. The research team also observed that patents induced by subsidies were not of lower-than-average quality. Firms receiving higher levels of subsidy also grew faster and employed more people.
Tax incentives have a greater impact on small firms than on large firms because small firms do not have the same cash reserves to fund the development of innovations. Most previous scientific studies underestimate the benefits of R&D relief because their findings concern larger firms.
Tax incentives for R&D were introduced in Finland in 2013, but the experiment was terminated prematurely in 2014. This is contrary to the international trend, with many countries gradually increasing tax relief for R&D activity. In the UK, where the firms examined in the study largely operate, the additional deduction for research and development activity has in recent years been up to 125 per cent of expenditure. The researchers calculate that without the relief overall investments in R&D in the UK would have been 10% lower than at present.
Einiö says “Well executed tax relief to research and development is good innovation policy. Taxpayers get a good return on their money.”
“The relief should be staggered to give smaller firms a bigger additional deduction. This can also create features in the tax system enabling reliable ex-post evaluation of the impact of the incentives.”
The study drew on a European Patent Office database comprising all patented innovations combined with financial statements and tax data for UK firms. A regression discontinuity method was implemented based on size thresholds in the tax system to compare firms just above and just below the threshold. The method is generally considered a highly reliable way to evaluate the impact of policy measures.
Senior Researcher Elias Einiö, VATT, tel. +358 295 519 408
'Do tax incentives for research increase firm innovation? An RD Design for R&D' by Antoine Dechezlepretre, Elias Elinio, Ralf Martin, Kieu-Trang Nguyen and John Van Reenen.