Do Tax Credits Stimulate R&D Spending? The Effect of the R&D Tax Credit in Its First Decade

49 Pages Posted: 30 May 2013 Last revised: 11 Mar 2015

See all articles by Nirupama Rao

Nirupama Rao

University of Michigan, Stephen M. Ross School of Business

Date Written: March 8, 2015

Abstract

This paper examines the impact of the R&D tax credit between 1981-1991 using confidential IRS data from corporate tax returns. The key advances on previous work are an instrumental variables strategy based on tax law changes that addresses the simultaneity between R&D spending and its user cost and the use of new confidential data. Estimates imply that a ten percent reduction in the user cost of R&D leads the average firm to increase its research intensity -- the ratio of R&D spending to sales -- by 11 percent in the short-run. Long-run estimates imply that firms do face adjustment costs and further increase spending over the longer-run. Analysis of the components of qualified research shows that wages and supplies account for the bulk of the increase in research spending. Comparisons of the elasticity across firms of different sizes, industries, tax status, multi-national status and credit history are also made. Neither small nor young firms appear more responsive in the static analysis but the dynamic model reveals stronger short-run responses, suggesting that they may face lower adjustment costs or liquidity constraints in financing R&D. Long-run and re-timing analyses show no evidence that firms allocate their qualified research spending over time to maximize their R&D tax credits. Elasticities of qualified and total research intensities from a smaller sample suggest firms respond to user cost changes largely by increasing their qualified spending, meaning that what R&D the federal credit deems qualified research is an important margin on which the credit affects firm behavior.

Keywords: R&D, Tax Credits

JEL Classification: O38, H25, G31

Suggested Citation

Rao, Nirupama, Do Tax Credits Stimulate R&D Spending? The Effect of the R&D Tax Credit in Its First Decade (March 8, 2015). NYU Wagner Research Paper No. 2272174, Available at SSRN: https://ssrn.com/abstract=2272174 or http://dx.doi.org/10.2139/ssrn.2272174

Nirupama Rao (Contact Author)

University of Michigan, Stephen M. Ross School of Business ( email )

Ann Arbor, MI
United States

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