Public policies: international comparisons

Transcription

1 Public policies: international comparisons Most governments actively support innovation through a variety of policy measures: direct aid via grants, subsidies, research contracts, and public procurement; indirect support for R&D via tax incentives; regulations on intellectual property rights, research joint ventures, and standards; R&D conducted in government laboratories and universities; and innovation systems based on universityindustry networks, educational systems, and venture capital. This paper focuses on tax incentives for innovation. First, we compare incentives in selected countries. Some have no tax incentives at all, some use tax credits based on R&D volume, and others rely on incremental R&D tax credits. Second, we survey the econometric evidence on the impact of tax incentives and attempt to compare the effectiveness of different policy measures. In closing, we examine the suitability of the standard approaches for assessing the efficiency of R&D tax incentives. Innovation and economic performance 83

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3 PUBLIC POLICIES: INTERNATIONAL COMPARISONS Pierre Mohnen Professor, University of Maastricht, Maastricht Economic Research Institute on Innovation and Technology (MERIT) Most governments actively support innovation through a variety of policy measures: direct aid via grants, subsidies, research contracts, and public procurement; indirect support for R&D via tax incentives; regulation of intellectual property rights, research joint ventures, and standards; publicfunded R&D conducted in government laboratories and universities; and innovation systems based on venture capital, universityindustry networks, and educational systems. This paper focuses on tax incentives for R&D. I shall compare the measures implemented in different countries, and offer some thoughts about the efficiency of these policies. Why is government involved in innovation? Government intervention in research is justified by what are known as market flaws. The main market flaw is due to research spillovers (externalities). Econometric studies have shown that because of research spillovers benefiting firms in the same industry or in neighboring industries, be they domestic or foreign the social rate of return on research and development (i.e., the return accruing to society as a whole, or at least to a section of it) exceeds the private or internal return on R&D (i.e., the return accruing to the firm that financed the research). The order of magnitude of the excess rate of return may be roughly estimated at 50%. Some spillovers may be negative, for example the duplication of research in a patent race. Positive spillovers apparently outweigh negative ones. Firms seeking to maximize their own profit make no allowance for these spillovers and thus do not perform the socially optimal volume of research. Another market flaw is due to the fact that research is seen as a public good, knowledge being a nonexclusive, nonrival good. This creates a need for mechanisms to enable firms to reap the benefits of research. Otherwise, they might be unwilling to invest in lowreturn projects. Research may sometimes require massive expenses and be characterized by high uncertainty that no single firm can handle. Some startups, moreover, have trouble financing their research, owing to the asymmetry of information between the firm and the funds provider regarding the research project s expected value. In addition to these economic motives, government may want to be involved in innovation to enhance national prestige or competitiveness. How does government intervene? To stimulate and support corporate research, government has a range of options including: direct measures: research scholarships, subsidies to innovative firms, procurement, and research contracts; indirect measures: tax relief, research tax credits, loans, and loan guarantees; regulation: rules to protect intellectual property (patents, brand copyright, royalties), cooperation agreements between universities and firms (or between firms), and the definition of standards; public R&D: comprises (1) R&D performed by government in public research laboratories and (2) research in publicfunded universities; infrastructure: all the factors relevant to social capital i.e., venture capital, education, the information highway, information centers, and technologytransfer centers. Innovation and economic performance 85

4 Comparison between direct and indirect aid To quantify the indirect aid to research, I have relied on statistics concerning the cost to government of R&D tax incentives expressed either as a proportion of total R&D in the goodsproducing industries or as a proportion of total governmentfunded R&D. These statistics show that two countries make great use of such mechanisms: Canada and the Netherlands. If we measure the cost of direct aid against the total cost of industrial innovation, we find that some countries such as the United States, France, and the United Kingdom place more emphasis on direct aid. Table 1 Size of direct aid and indirect aid Country Cost of tax incentives/industrial R&D* (%) Cost of tax incentives/governmentfunded R&D* (%) Cost of direct aid/ total aid to industrial technology** (%) Germany 60 Canada United States Finland 52 France Japan Netherlands United Kingdom 77 Sources: *OECD; National Science Foundation; Sheehan (2002); **OECD pilot study, (subsidies and contracts); Young (2002) The advantage of direct measures is that they can be targeted at specific projects whose social return substantially exceeds the private return. However, there may be a greater moral hazard in supporting research through selective direct aid rather than nonselective indirect aid the latter being, in principle, available to anyone engaged in research. For example, the money could go to politically influential regions or enterprises rather than to promising projects. There is also the delicate problem of picking a winner. Does government really have the information it needs to make a better choice than the market? The advantage of indirect measures is that they support all research efforts that qualify as such and so let the market decide which research projects deserve to go ahead. The aid allocation procedure is faster and nearly automatic, and the firm is sure of receiving support if it engages in R&D as defined in the Frascati Manual. By contrast, for government, the costs of tax incentives are more unpredictable. There is also more deadweight loss through indirect aid, given the constant risk of backing projects that would have been launched anyway. The different types of tax incentives Tax incentives fall into two broad categories: tax credits or deductions based on the volume of research expenditures that come on top of deductions for current expenditures and accelerated or linear depreciation for capital spending; tax credits or deductions based on the increase in R&D, which is computed from a fixed or variable base. Another alternative consists of measures to offset possible caps on tax relief. Tax credits, for example, can be made refundable, so that even a firm with no tax liability will be eligible for a taxcredit refund. Or the credits can be carried forward or back to another fiscal year, or transferred to other beneficiaries. 86 Insee Méthodes

5 To some extent, even indirect incentives can be targeted at (1) selected expenditures, such as research in healthcare, defense, agriculture or the environment (Canada), or (2) selected players, such as universities (Denmark, Japan), small and mediumsized enterprises (Belgium, Italy, Japan), or specific regions (Germany, Italy, Canada). Other, more complex indirect tax incentives can be designed, such as exemptions from capitalgains tax and tax relief on dividends from investments financed by venture capital. International comparisons of R&D tax treatment The Bindex concept is defined as the ratio of (1) the net cost of a euro spent on R&D, after deduction of all tax incentives, to (2) the net income generated by one euro of revenues. For example, if a firm can deduct its entire R&D expenditures from its tax base, at a corporate income tax rate of 50%, and if it qualifies for a 20% tax credit on those expenditures, the net cost to the firm will be: (1 0.5) x (1 0.2), which, divided by an aftertax profit of (1 0.5), gives a Bindex of 0.8. In other words, a firm needs to earn 80 eurocents in pretax profits to recover its net R&D outlay of 40 eurocents. One group of countries base their tax credits on the volume of R&D spending (the Netherlands), a second group uses incremental R&D tax credits (France, United States, Japan), a third group uses both measures (Canada), and a fourth group uses none at all (Germany, United Kingdom). Table 2 International comparison of tax incentives to R&D Type of tax credit Volume Increment Both None Country (Bindex for large firms in parentheses) Netherlands (0.904) United States (0.934), France (0.915), Japan (0.981) Canada (0.827) Germany (1.041), Finland (1.009), United Kingdom (1.000) Source: Warda (2002) If the Bindex exceeds 1, the country offers hardly any tax incentives. The more it is below 1, the more the country offers some form of tax incentives for R&D. The United Kingdom s new R&D policy is moving toward a volumebased tax credit for large firms and a specific incentive for small and mediumsized enterprises. The Netherlands have been implementing since 1994 a policy based on tax credits linked to research staff compensation: firms engaged in R&D can deduct the credits monthly from their taxes and socialsecurity contributions. Spain has calculated its tax credits since 1999 on the basis of innovation expenditures, as defined by the Oslo Manual, i.e., in addition to R&D spending, the expenditures incurred in purchasing patents, in training employees for the manufacture of new products or the use of new technologies, and in marketing new products. How should the efficiency of tax incentives be assessed? Ideally, we should perform a costbenefit analysis that would include the following factors: the propensity of firms to engage in R&D with and without tax incentives; the social return on additional research; the opportunity cost of tax expenditures (promotion of the arts, healthcare, aid for the homeless, etc.); policyimplementation costs (auditors, inspectors); and the cost to firms of applying for the tax credits (accountants, lawyers, etc.). In practice, we prefer to use the additionality criterion: we try to determine whether one euro spent by government generates at least one euro of additional research. If the answer is yes, the policy is a good one. The method requires a correct measurement of the Bindex i.e., of all the tax parameters that enter into the determination of the cost of capital but also an accurate assessment of the price elasticity of research. For best results, we should also take account of the following parameters: a potentially different return on R&D induced by tax incentives; possible complementarities between R&D and other factors of production; research spillovers; Innovation and economic performance 87

6 spillovers from additional research; strategic effects; lags in the effects of tax incentives; deadweight losses due to support for research programs that would have been carried out anyway. Some empirical evidence of the efficiency of tax incentives In a study published in 1985, Mansfield and Switzer determined that the value of the R&D performed by Canadian firms per dollar of tax expenditures was 0.4. The Australian Bureau of Industry Economics found a figure ranging from 0.6 to 1. A Canadian study on corporate data (Bernstein, 1986) put the price elasticity of research at 0.13 for the short term and 0.32 for the long term. Table 3 Some econometric results on the efficiency of R&D tax incentives Study Data R&D price elasticities R&D/fiscal spending (%) MansfieldSwitzer (1985) Canada, firms Survey responses 0.4 Bureau of Industry Economics (1993) Australia, firms Survey responses Bernstein (1986) Canada, firms 0.13 (ST), 0.32 (LT) 0.8 Hall (1993) United States, firms Hines (1993) United States, firms Bloom et al. (1998) G7 and Australia 0.16 (ST), 1.1 (LT) Dagenais et al. (1997) Canada, firms Brouwer et al. (2002) Netherlands, firms 0.11 (ST), 1.12 (LT) Mairesse and Mulkay (2002) France, firms Guellec and van Pottelsberghe (2003) 17 countries Sources: Dagenais et al. (1997); Hall and van Reenen (2000) 0.28 (ST), 0.31 (LT) A study by Bronwyn Hall on 1993 U.S. data finds a higher elasticity of 1.5, reflecting a ratio of R&D to tax expenditures of 2. A study by Nicholas Bloom, Rachel Griffith, and John van Reenen on macroeconomic data for the G7 and Australia estimates elasticity at between 0.16 (in the short term) and 1.1 (in the long term). The recent study by Jacques Mairesse and Benoît Mulkay finds a higher elasticity, close to the figure obtained by Bronwyn Hall. If we use these elasticities to calculate the value of research induced per euro of tax expenditures, we obtain nearunit ratios most of the time. There are two exceptions: Hall (1993) and Mairesse and Mulkay (2002) find ratios well in excess of unity. A partial explanation of their result may be that the tax credits examined in both studies are incremental. Dagenais et al. (1997) also report different results for volume tax credits and incremental tax credits. Volume tax credit versus incremental tax credit: which is better? Volume tax credit is more attractive because it is more transparent, more predictable, and less subject to cyclical fluctuations. However, there are two drawbacks: the risk of financing R&D that would have been performed anyway, and the fact that most of the credits go to big firms. For incremental tax credits, as implemented in France, the induced stimulus from incremental research is dampened by the increase in the tax base that results from the incremental research. Incremental tax credits also tend to lead to stopandgo patterns of R&D outlays over time (Lemaire 1996). It is not necessarily a good idea to have firms modify their R&D plans in order to benefit from tax credits. Incremental R&D tax credits may become unusable (if the firm reaches a ceiling) and generate a negative impact on research (Eisner et al. 1984). 88 Insee Méthodes

7 By contrast, the incremental research tax credit looks very efficient when measured against tax expenditures, as it subsidizes only additional R&D outlays. Conclusion We find a fairly wide divergence between national policies to stimulate innovation, even as regards R&D tax incentives. Indeed, it is quite possible that the same incentives are not suitable for all countries. Most empirical studies seem to show that one euro of tax expenditure generates roughly one euro of additional research. The effect is stronger if we include spillovers, if we take a longterm view, and if the tax credits are restricted to incremental research. Some studies have also shown that a stable policy of R&D tax incentives is preferable. As each policy measure has its limits and adverse effects, it is probably better for a government not to rely exclusively on tax incentives for innovation, but rather to implement a range of policies including support for innovation through direct and indirect measures, education programs, regulations, and so on. To give just one example, what is the use of tax credits if there is an acute shortage of researchers in the labor market? Innovation and economic performance 89

8 References Dagenais, M., Mohnen, P., and Therrien, P. (1997), Do Canadian Firms Respond to Fiscal Incentives to Research and Development?, Cahier du CIRANO 97s34. Eisner, R., Albert, S.H., and Sullivan, M. (1984), The New Incremental Tax Credit for R&D: Incentive or Disincentive?, National Tax Journal, 37, pp Hall, B. and van Reenen, J. (2000), How Effective Are Fiscal Incentives for R&D? A Review of the Evidence, Research Policy, 29, pp Lemaire, I. (1996), Optimal firm response to incremental tax credits, Cahier de recherche du CREST no Sheehan, J. (2002), Policy Instruments for Financing Business R&D: Finding an Appropriate Mix, presentation at the EC Workshop on Fiscal Incentives for R&D, Brussels, Jan 2223, Warda, J. (2002), Measuring the value of R&D tax treatments in OECD countries, STI Review, 27, pp Young, A. (2002), Improving measures of government support to industrial technology, STI Review, 27, pp Insee Méthodes