Tax incentives for R&D: are they effective?

Boosting research and development investment remains one of the top priorities for advanced economies, not least because R&D is an important driver of innovation and long-run economic growth. Besides, the transition to a sustainable economy calls for new technologies. So, providing incentives and the necessary conditions for R&D investment by the business sector ranks high on the innovation policy agenda of OECD countries and partner economies (Appelt et al., 2019). In the same vein, one of the key targets of the Europe 2020 strategy is for 3 % of EU GDP to be invested in R&D by the end of 2020.

However, private business investment in R&D tends to be sub-optimal due to the wedge between its private and social returns. Government involvement in promoting business R&D investment is thus highly justified. To address the private sector’s under-investment in R&D, governments have different policy responses at their disposal. They can choose between direct support instruments, such as direct R&D subsidies, and indirect support mechanisms via tax incentives for research and development work. Nevertheless, in the post- COVID-19 environment when governments will need to restore sustainability of public finances, and raise public policy efficiency, the question arises whether public support mechanisms for private sector R&D investment are actually effective. This article focuses on the effectiveness of input-related R&D tax incentives.

Over the last decade, R&D tax support has increased significantly in Belgium and in the European Union. The main R&D tax relief provisions in Belgium are, in terms of input-related R&D support, schemes for the partial exemption from payment of withholding tax on the wages of R&D employees and the R&D tax credit or investment deduction in the corporate tax system. When it comes to targeting the output of innovation, Belgium has a system where IP-derived income is taxed well below the statutory tax rate.

A sizeable volume of empirical research has been done to assess the effectiveness of public R&D support mechanisms. Compared to some earlier studies, recent evidence suggests more unanimously that both direct public support and R&D tax incentives have a significant positive effect on private R&D investment. Governments’ optimal choice of exact policy instrument, however, depends on the type of firms targeted. Direct subsidies mainly have an impact on small and young firms’ R&D decisions, while R&D tax incentives are more market-oriented as the decision on which projects to invest in is left up to the firms themselves. Larger firms seem to benefit more from the latter. To some extent, R&D subsidies and tax relief measures might be substitutes, as their effectiveness declines when firms benefit from both at the same time.

For Belgium, the evidence on the effectiveness of R&D tax incentives is somewhat mixed. Dumont (2019) shows that the partial withholding tax exemption schemes significantly contribute to stimulating private R&D investment, whereas the stimulating impact of the R&D tax credit cannot consistently be illustrated. In Belgium, only a small amount of R&D spending comes from young firms, and these firms often have the best growth potential. It could therefore be beneficial to rethink Belgian R&D support mechanisms.