Tax Incentives for Research and Development: Policy Design and Evidence

This chapter reviews the economic theory and empirical evidence on research and development tax incentives, with a focus on US policy. Although the economic evidence strongly supports the conclusion that tax credits stimulate research and development, estimates of the sensitivity vary widely across countries, over time, and by firm types. In particular, there is increasing evidence that small firms are more responsive to research and development tax incentives, even though large multinationals account for the majority of tax expenditure. The US system allows firms to deduct qualifying research and development from taxable profits and 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 research and development. We suggest several ideas for simplification of the US credit.