Innovation on hold: Tax incentives and R&D crowding-out effects among SMEs in Vietnam

Tax incentives as a key public policy instrument to drive firms’ innovation have become of increasing interest for both researchers and governments in recent years. This article evaluates the impact of tax incentives on SME firms’ technological innovation performance. It also analyzes whether government support, particularly tax incentives, has complemented or substituted for research and development (R&D) intensity. Using firm-level panel data with an instrumental variables strategy, our results indicate that receiving the tax incentive substitutes for small and medium-sized enterprises’ R&D intensity by approximately 3 percent, showing a crowding-out effect. Indeed, firms who received higher tax incentives invest less in R&D compared to nonreceiving firms, pointing to “sand-the-wheel” effects. We theorize collusive relationships between firms and political entities that incentivize firms to expand their political networks rather than invest in uncertain and high-risk R&D projects. The unexpected findings provide policy implications for greater transparent and accountable administration in the tax system.