Tax Incentives for Research and Development: Policy Design and Evidence

This chapter reviews the economic theory and empirical evidence on R&D tax incentives, with a focus on US policy. While the economic evidence strongly supports the conclusion that tax credits stimulate R&D, estimates of the sensitivity vary widely across countries, over time and firm types. In particular, there is increasing evidence that small firms are more responsive to R&D tax incentives, even though large multinationals account for majority of tax expenditure. The US system allows firms to deduct qualifying R&D from taxable profits and also provides an incremental tax credit for spending above a firm-specific base. However, complex base rules lead to effective credit rates that are far below the statutory rate for most firms, and can produce dynamic disincentives for R&D. We suggest several ideas for simplification of the US credit.