Business Taxes Slow Innovation

An increase in local business taxes has a negative impact on innovation in companies and economic growth in Germany. Higher taxes cause companies to reallocate their research and development (R&D) activities or abandon them altogether. As a result, the number of newly registered patents decreases, and with it the competitiveness in the market. This is the conclusion of an international team of researchers who examined how changes in local business tax rates slowed innovation over a 30-year period. “Higher taxation on companies leads them to reduce their investment in research and development, regardless of the company’s size. It is worthwhile for policymakers to take a closer look at this matter. So far, tax incentives for R&D have often been closely linked to the size of a company,” says Professor Sebastian Siegloch, head of the ZEW Research Department “Social Policy and Redistribution”. Under the Research Allowance Act implemented in Germany in 2019, all businesses conducting R&D have access to research allowances, which is a reasonable approach.

In addition, the study found that direct tax incentives for research and development are more efficient than a simple reduction in profit taxation for companies. A lower corporate income or local business tax could provide a positive stimulus for innovation, but at the same time would lead to significant tax losses, since all companies, both those that conduct research and those that do not, pay profit tax. Targeted tax incentives could generate the same positive impulse for innovation at lower fiscal costs. 

The study also confirmed that it has a negative impact on overall economic growth when companies withdraw from research for tax reasons. Less innovation leads to fewer new patents and ultimately a loss of competitive advantage. This development can be quantified: “The tax-induced decline in innovation alone is responsible for about eight per cent of the total negative GDP effect resulting from the increase in local business taxes,” says Siegloch.