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Small Business Economics

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01.10.2014

Tax incentives… or subsidies for business R&D?

verfasst von: Isabel Busom, Beatriz Corchuelo, Ester Martínez-Ros

Erschienen in: Small Business Economics | Ausgabe 3/2014

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Abstract

We study whether firms’ actual use of R&D subsidies and tax incentives is correlated with financing constraints -internal and external- and appropriability difficulties and investigate whether both tools are substitutes. We compare the use of both policies by SMEs and by large firms and find significant differences both across instruments and across firm size. For SMEs, financing constraints are negatively correlated with the use of tax of credits, while they are positively associated with the likelihood of receiving a subsidy. The use of legal methods to protect intellectual property is positively correlated with the probability of using tax incentives, but not with the use of subsidies. For large firms external financing constraints are correlated with instrument use, but results regarding appropriability are ambiguous. Our findings suggest that (1) direct funding and tax credits are not perfect substitutes in terms of their ability to reach firms experiencing barriers associated to market failures; (2) one size may not fit all in innovation policy when the type or intensity of market failure differs across firm size, and (3) subsidies may be better suited than tax credits to encourage firms, especially young knowledge-based firms, to start doing R&D.

Vorheriger Artikel Female self-employment and children

Nächster Artikel Strategic reference points in family firms

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Appropriability refers to the degree to which a firm captures the value or returns created by innovation (Cassiman and Veugelers 2002).

The concern about the design of an optimal policy mix is expressed in OECD’s documents on innovation policy (see OECD 2010, chapter 4) and in the testimony by the OECD for the US Senate Committee on Finance, OECD 2011b.

Project and firm level data have been used by Huergo and Trenado (2010) to study the allocation process of subsidized loans in Spain, distinguishing between the firm’s application and the agency’s awarding decisions. They find that exporters are more likely to apply, while conditional on applying the agency is more likely to award support according to the firm's technical capability and export potential. Differences between SMEs and large firms and the role of appropriability are not considered. Hussinger (2008) uses a credit rating index and finds that firms with better rating are more likely to obtain direct public funding in Germany.

In the Appendix we provide a more detailed account of both policy tools and information sources. Using information from the National Statistical Institute on the number of firms that conduct in-house R&D activities, we estimate that the number of claimants is about 25 % of potential claimants.

PITEC is the acronym for “Panel de Innovación Tecnológica en las Empresas”. A description of the survey can be found at the following link (in Spanish): http://www.ine.es/. Mairesse and Mohnen (2010), discuss some of the Community Innovation Survey features and shortcomings.

The total number of firms that declare using tax incentives in 2008 in PITEC is 1742 (manufacturing and services). We estimate that our sample covers thus about 55 % of all claimants that year.

In the PITEC different sampling procedures are used for large firms (200 or more employees) and SMEs. All large firms are surveyed. For SMEs, all firms that have received any form of public support for R&D, have reported R&D expenses in the current or past years and a stratified random sample of non-R&D performing firms are surveyed. Innovators are over represented in this sample: over 50 % of SMEs in the PITEC sample invest in R&D against 13 % in the population, according to INE.

According to data provided by the tax authorities (Agencia Estatal de la Administración Tributaria and Dirección General de Tributos), large firms’ share of total R&D deductions is about 73 %.

In our sample, not all firms that were investing in in-house R&D in 2005 claimed tax credits in subsequent years (36 % of SMEs and 57 % of large firms did). Many firms, mostly SMEs, declare that the main reason for not claiming is that their R&D expenditure is too low; while some large firms declare that their type of R&D did not fit eligible expenditures.

While some theoretical literature has compared patents, prizes and subsidies as innovation policy tools (Wright 1983; Fu et al. 2012), to the best of our knowledge tax incentives have not been explicitly included in these comparisons.

There are significant differences across countries in the specific design of direct support. In the United States, the description of SBIR program, which targets SMEs (see http://www.sbir.gov) states that R&D risk and fixed costs are key motivations for the program. Public agencies involved with the program set R&D topics in solicitations. In Finland, the public agency Tekes values the degree of novelty and research intensity of projects but does not appear to target particular fields (http://www.tekes.fi). The Spanish case is similar to the Finnish. See Huergo and Trenado (2010) for a detailed description of the Spanish case.

Once the firm has had a project proposal approved, it may be able to obtain additional funding from the private sector. Agency approval may act as a quality certification, as shown in Takalo and Tanayama (2010).

This obviously depends on the specific design of R&D tax incentives. In Spain and France firms that invest in R&D can obtain a deduction from their tax liability, which therefore has to be positive at some point (both systems contain carry-forward provisions). In the Netherlands the R&D deduction is applied to wages paid to R&D staff, and in the UK SMEs can get a cash refund; the deduction is thus independent of the firm’s tax position in these countries.

A similar ongoing discussion in the US concerns provision of support for college education through tax credits versus through grants or loans. See Long (2004).

Hajivassiliou and Savignac (2011) find evidence suggesting that constrained firms are less likely to start innovative projects.

Previous empirical work (González et al. 2005; Mañez-Castillejo et al. 2009; Arqué and Mohnen 2012), provides evidence that sunk costs are an entry barrier for some firms. Aw et al. (2011), who study the relationship between R&D and exporting in a dynamic setting, also find evidence consistent with the presence of sunk costs in both activities.

EU communications concerning innovation policy appeal to market failures as one of the motivations for public support. This is public information, so it is not unreasonable to formulate the expected subsidy this way. In addition, public agencies usually publish annual reports and other periodical publications that provide some information about the support that has been granted. For instance in Spain the agency publishes yearly a list of projects and firms that have obtained support; from this information, as well as on agency information describing eligibility for support, a firm can build realistic expectations regarding the likelihood of obtaining a grant and/or a loan for a project.

To simplify notation, subscripts are omitted hereafter.

In the corporate taxation literature, Keuschnigg and Ribi (2010) predict that R&D tax credits will not only encourage innovation but also relax financing constraints and help innovative firms to exploit investment opportunities to a larger extent. Edgerton (2010), however, finds that the responsiveness to investment tax incentives varies with firm cash flows. We believe that even without knowledge spillovers, SMEs and young firms that are financially constrained will be less likely to benefit from R&D tax credits. Large firms, however, can have positive taxable income from other activities, and the expected tax credit may be more predictable, helping them mitigate mild appropriability or financing constraints.

In practice, some firms may perform incremental R&D that would not qualify for a subsidy, but might qualify for a tax credit. Compliance costs and fear of a tax audit may deter some of those firms from claiming tax credits. See also footnote 12.

Regional or local governments do not provide R&D tax incentives. Regarding direct support, some firms may obtain additional funds from local, central or European administrations, but eligibility criteria for support may differ across government levels, so aggregation over jurisdictions might distort results (Blanes and Busom 2004). Since R&D tax incentives are a policy implemented at the Central government level, they should be compared to direct support provided by the same government level.

We later test for the sensitivity of results to changes in the definition of the dependent variables, and to the use annual observations.

Hajivassiliou and Savignac (2011) use a French firm-level data set that includes subjective, direct indicators of financing constraints similar to ours as well as objective but indirect indicators such as leverage ratio, cash flow or the profit margin. They find that they are highly correlated.

In our sensitivity analysis, we will redefine financing constraints as a binary variable equal to 1 if the firm considers that lack of internal or external funds is of high importance. We also construct a control variable that captures the firm’s overall perception of difficulties (awareness of constraints).

Secrecy may be a preferred option for some projects or firms. The survey does not include any direct question related to the firm’s concern for imitation by rivals, which would provide a direct indicator of expected appropriability difficulties. Firms are only asked about the actual use of legal protection mechanisms. We assume that use of these mechanisms signals that a firm believes that threat of imitation is important and that using legal protection may prevent it at least to some extent.

Dependent variables are obtained from PITEC 2008 survey, while independent variables are taken from PITEC 2005 in order to deal at least partially with potential endogeneity issues.

Regarding SMEs and acess to financing for innovation, see Beck et al. (2008), Hall and Lerner (2010) and Canton et al. (2013).

In the case of tax incentives, different credit rates or different caps may be applied to SMEs, as is our case.

We perform several tests. We test for equality of coefficients of our core variables across the two equations in the bivariate model. The null is rejected in the case of SMEs, but not for large firms. Chi square tests not reported in the tables but are available on request. As a specification test, we perform a test for normality of residuals (Chiburis 2010).

One possible explantation is that past protection use is an imperfect approximation to appropriability of approved projects; a second possibility is that it may be difficult for the agency to evaluate the degree of appropriability of an R&D project, so that financing constraints carry more weight in the decision rule; it is also possible that firms do not submit proposals for R&D projects that do not reach some appropriability threshold.

The inclusion of the interaction term does not affect the average marginal effect of remaining variables. An alternative way to test for interaction effects is to create a binary variable for each combination of appropriability difficulties and financing constraints. Estimation results show that relative to firms that protect and do not face important financing constraints, those that suffer from both problems are 7 pp. less likely to use tax credits only, 2 pp. more likely to use a subsidy only, and 2 pp. less likely to use both types of support.

Our results differ from Gelabert et al. (2009) with respect to the relationship between financing constraints and the likelihood of using subsidies. This might be partly explained by differences in sample composition, as theirs consists of firms that reported positive internal R&D expenditure at least one of these years in all sectors, and average firm size is large.

In particular, our finding that financially constrained SMEs are less likely to use tax credits is in line with Edgerton 2010.

We also check whether changing the definition of SMEs from those with <200 employees to those with <250 and turnover less than €50 million, in line with the standard Eurostat definition, changes results. It does not. Results are available upon request.

Remaining variables as in the baseline. Detailed results are available on request.

To the extent that large firms have lower appropriability and internal financing difficulties; there might be more room for some crowding out as found by Lokshin and Mohnen (2012).

The use of multiple policy instruments to address private underinvestment in R&D may be optimal in a second-best world with multiple market failures, coupled with informational, political and administrative capacity constraints. These issues have been considered in the design and implementation of environmental policies (Bennear and Stavins 2007), and may be relevant for innovation policy as well.

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Titel: Tax incentives… or subsidies for business R&D?
verfasst von: Isabel Busom
Beatriz Corchuelo
Ester Martínez-Ros
Publikationsdatum: 01.10.2014
Verlag: Springer US
Erschienen in: Small Business Economics / Ausgabe 3/2014
Print ISSN: 0921-898X
Elektronische ISSN: 1573-0913
DOI: https://doi.org/10.1007/s11187-014-9569-1

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