Are Research and Development Tax Credits Effective? the Economic Impacts of a R&d Tax Credit in New Hampshire
Gittell, Ross, Tebaldi, Edinaldo, Public Finance and Management
This paper uses detailed study of a proposed research and development (R&D) tax credit in one U.S. state, New Hampshire, to gain insight on an important public finance issue: the motivations for and the economic costs and benefits of R&D tax credits. The paper reviews the policy considerations and assesses the potential economic impacts of enacting a proposed R&D tax credit in New Hampshire in 2006. Policy analysis and formal economic modeling of the economic costs and benefits of alternative R&D tax credit policies are provided for New Hampshire. This includes estimates of the potential employment and personal income gains, changes in R&D investments, and tax revenue costs. The review of the state R&D tax credit policies and the New Hampshire modeling and simulations support the view that a R&D tax credit policy can have a positive impact on a state's R&D investments, employment and income growth. It also highlights, however, that the net fiscal effect can be negative and that the aggregate (national) welfare effects are not adequately considered and require further inquiry.
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Economic theory and empirical evidence suggest that innovation and new product development will be key factors in economic competitiveness and growth in the next century. The main driver of innovation and new products are research and development (R&D) activities (Solow, 1956; Romer, 1990; Tebaldi and Elmslie 2006). Public officials and economic policy makers have responded with policies aimed at increasing R&D investments. Research and Development (R&D) tax credits have emerged as one of the preferred tools for promoting and expanding R&D spending (Atkinson, 2007; Wilson, 2007; Hall and Wosin-ska, 1999). R&D tax credits reduce private firm R&D costs and, therefore, can spur increased R&D investment. They can be the first step in what has been described as a virtuous economic cycle, contributing to productivity growth, new product development, and the expansion of exports that can result in overall economic growth and enhanced quality of life (Atkinson, 2007).
In 1981 the United States (U.S.) Congress enacted a federal research and development tax credit on research expenditures aimed at encouraging investment in R&D and improving U.S. economic competitiveness. The U.S. federal R&D tax credit was reauthorized in 2006 at 20 percent credit for incremental R&D investment.1 Many nations including France, Japan, the United Kingdom, Australia, Spain, Korea, India, Singapore, Ireland, and Italy also offer R&D tax credits (see Table A1 in the appendix for detail on the R&D tax credit policies). In some cases the R&D tax credit in these countries are significantly higher than in the United States. For instance, Canadian corporations can claim a R&D tax credit of up to 35 percent of R&D expenditures and French companies can claim a 10 percent flat credit and a 40 percent credit for R&D expenditures in excess of average R&D spending over the two previous years (R&D Credit Coalition, 2007). Sakata, Fujisue and Oku-mura (2005) indentify that the incentives that induce R&D investments are smaller in the U.S. than in Spain, Canada, South Korea, Netherlands, and the United Kingdom. And, a recent study by KPMG (2006) finds that the U.S.'s R&D costs are higher than the R&D costs in Canada, France, Italy and United Kingdom.2
In response to domestic and international competition for R&D activities, many states in the U.S. have adopted tax incentives for R&D that are in addition to the federal tax credit. As of January 2007, 40 (out of the 50)3 states had a tax credit on R&D expenditures (see Figure 1 below). The generosity of the state-level R&D tax credit varies significantly, ranging from relatively small credits in Maine and Kansas to about 20 percent effective R&D tax credits in Rhode Island and Hawaii (see Table A2 in the appendix). …