The Impact of R&D Tax Incentives on R&D Costs and Income Tax Burden

The structure of public support to corporate R&D has been rapidly changing over the last decade. Government R&D policies are increasingly oriented towards market signals and competition in order to minimise the potential distortions in the R&D decisions of firms. This led several countries introduce tax-based R&D incentives in addition to project-specific direct subsidies. A recent development in funding R&D therefore is the shift towards a higher share of indirect funding through tax incentives rather than direct subsidies. Significant tax incentives for R&D in most of the OECD member states have been introduced or modified within the past decades. Countries apply several forms of R&D tax incentives which all reduce taxes at the level of the company. First, a common form of incentive is to reduce the company’s taxable base by allowing extra amounts to be deducted over current R&D expenses from the taxable income (deduction), or by accelerated depreciation of assets. Second, there are tax credits which reduce the tax due and are determined based on the amount of R&D expenses. Third, special tax rates or even zero-tax rates are granted to firms under certain conditions, e.g. for young innovative corporations. A fourth form of R&D tax incentives is to reduce wage taxes for R&D personnel and thus reduce employment costs. The B-Index by Warda (2001) is a frequently used indicator that compares the different forms of R&D tax incentives across countries. This indicator is well accepted but it has some shortcomings when it comes to tax incentives with limitations or companies with losses or poor profitability of companies. In this paper, we analyse R&D tax incentives in a more detailed way, in a multi-period setting and under economic assumptions which reflect a more realistic setting. We measure the incentive’s impact on the firm’s total tax payments (effective tax burden) and the R&D cost by means of the simulation model European Tax Analyzer. Using different economic settings and model firms, we run sensitivity analyses and get by that a more detailed view on the effects from R&D tax incentives. The results show that R&D tax incentives in the EU-27 member states have a significant impact on the effective corporate tax burden. Countries with highest tax subsidies are Portugal, Spain, and the Czech Republic. The level of tax subsidies does not depend so much on the kind of incentive but rather on its design. We analysed the impact of certain design parameters of R&D incentives as well as the framing tax regime on the effective tax burden and on the resulting tax subsidy. Taking e.g. Spain and Hungary, where the granted tax incentives often cannot be used in the period in which expenditures have taken place, it becomes evident that the design of the tax incentive must be in accordance with the framing tax system in order to be efficient. An immediate cash refund in case tax incentives cannot be used in the respective period is found to be a good solution for this problem. The most important drivers of tax subsidies turned out to be the design of the incentive itself, its fitting to the general tax system, and the firm’s profitability relative to the level of R&D expenditures.

Elschner, Christina and Christof Ernst (2008), The Impact of R&D Tax Incentives on R&D Costs and Income Tax Burden, ZEW Discussion Paper No. 08-124, Mannheim.