Welfare Effects of R&D Support Policies

Abstract

We conduct a welfare analysis of R&D subsidies and tax credits using a model of innovation policy incorporating externalities, limited R&D participation and financial market imperfections. We estimate the model using R&D project level data from Finland. The intensive, not the extensive R&D margin is important. Financial frictions do not matter much. Tax credits and subsidies do not reach first best but increase R&D 30-50% compared to laissez-faire. Once the subsidy application costs are accounted for, tax credits increase welfare by 1% and subsidies slightly reduce welfare. In terms of fiscal cost, tax credits are 90% more expensive than R&D subsidies.

Keywords: R&D subsidies, R&D tax credits, extensive and intensive margin, financial market imperfections, welfare, counterfactual, economic growth