NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Do Tax Credits Affect R&D Expenditures by Small Firms? Evidence from Canada

Ajay Agrawal, Carlos Rosell, Timothy S. Simcoe

NBER Working Paper No. 20615
Issued in October 2014
NBER Program(s):Public Economics, Productivity, Innovation, and Entrepreneurship

We exploit a change in eligibility rules for the Canadian Scientific Research and Experimental Development (SRED) tax credit to gain insight on how tax credits impact small-firm R&D expenditures. After a 2004 program change, privately owned firms that became eligible for a 35 percent tax credit (up from a 20 percent rate) on a greater amount of qualifying R&D expenditures increased their R&D spending by an average of 15 percent. Using policy-induced variation in tax rates and R&D tax credits, we estimate the after-tax cost elasticity of R&D to be roughly -1.5. We also show that the response to changes in the after-tax cost of R&D is larger for contract R&D expenditures than for the R&D wage bill and is larger for firms that (a) perform contract R&D services or (b) recently made R&D-related capital investments. We interpret this heterogeneity as evidence that small firms face fixed adjustment costs that lower their responsiveness to a change in the after-tax cost of R&D.

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Document Object Identifier (DOI): 10.3386/w20615

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