R&D tax credits across the EU: nonsense or common sense? A dynamic panel data approach

We re-examine the R&D – innovation – productivity nexus in 8 EU countries in the context of the possible introduction of an EU-wide R&D tax credit (R&DTC), using panels of industries with a long time dimension. We add long-run dynamics to the innovation production function and extended production function models, taking the availability/unavailability of national R&DTCs into account. Our benchmark estimates, obtained with panel ARDL models complemented by cointegration tests, suggest that R&DTCs may be associated with more innovation and/or a higher level of productivity, but only in a small group of countries. Disentangling the respective effects of business and government-sponsored R&D allows us to identify cointegrating long-run relationships between R&D, innovation and/or productivity in almost all countries. These relationships take a variety of shapes, which do not systematically give a significant (let alone positive) role to R&DTCs. Other instruments, such as targeted subsidies, may prove as effective. The main policy implication of these results is that a harmonized R&DTC at the EU level may be slightly premature. Complementary analyses suggest that targeting specific industries may make such a policy more effective.