Borderline Case International Tax Policy, Corporate Research and Development, and Investment (1997) / Chapter Skim
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3 R&D TAX INCENTIVES AND MANUFACTURING-SECTOR R&D EXPENDITURES
3 R&D TAX INCENTIVES AND MANUFACTURING-SECTOR R&D EXPENDITURES
Pages 53-64
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From page 53... ...
MAMUNEAS University of Cyprus INTRODUCTION An important characteristic of R&D investment distinguishing it from other types of investment is that its output has the properties of public goods; it can be considered at least partially nonexcludable and nonrivalrous.i Indeed, the empirical literature provides extensive evidence that not only is the rate of return of privately funded R&D investment very high compared to that of investment in physical capital, but more importantly, its social rate of return is several times higher than its private rate of return.2 This suggests that there are substantial externalities or spillover effects associated with R&D investment. Therefore, privately financed R&D is suboptimal, and the direct or indirect support of government is justified.
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From page 54... ...
To answer these questions, we estimated a cost function, taking into account the level of output, prices of the traditional inputs such as labor and private capital, the rental price of company-financed R&D capital, and the capital stocks of publicly financed R&D.3 Cost and factor demand functions for the private factors of production including industry-financed R&D capital stock are estimated jointly.4 In this framework, input demands are interrelated; changes in the price of one input affect demand for other inputs. For example, changes in tax incentives for physical plant and equipment affect not only the demand for physical capital but also the decision to invest in R&D activities.
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From page 55... ...
One, in place since 1954, is the immediate deductibility provision of company-financed R&D expenditures. The second is the direct R&E tax credit introduced by the Economic Recovery Tax Act of 1981.
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From page 56... ...
. 9Similar rental prices are constructed in the model for the physical capital by taking account of various taxes and subsidies that pertain to plant and equipment investment.
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1. The pattern of the own-price elasticities of labor, physical capital, and intermediate inputs varies from one industry to another, whereas the ownprice elasticity of company-financed R&D capital does not vary much from industry to industry.
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From page 58... ...
Our results suggest that increases in the prices of labor and physical capital lead to an increase in private R&D investment. This implies that any input price changes induced by government tax policies, whether payroll taxes, corporate taxes, or tax credits and incentives for investment in plant and equipment, will have a significant indirect effect on R&D investment.
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From page 59... ...
This amounts to approximately 40 percent of the total privately financed R&D of the entire manufacturing sector. Moreover, if one takes into account the fact that government directly finances about 30 percent of total R&D performed in the manufacturing sector, the role of the federal government in support of R&D is quite clear.
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From page 60... ...
With these assumptions, our estimates imply that the additional cost for the industry of the revenues saved by the government would be about $16.9 billion, but the reduction of R&D tax incentives in turn increases the rental price of company-financed R&D, leading to a reduction of $16.2 billion in private R&D investment. The cost increases and reductions in R&D investment are not uniform across industries.
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From page 61... ...
for an extensive review of the history, methodological issues, and regulations pertaining to the R&E tax credit in the United States and other Organization for Economic Cooperation and Development (OECD) countries.
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For example, in our study, an increase in the rental price of physical capital or the price of labor induces firms to invest more in R&D. The existing R&E tax credit has been at best a modest success.
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From page 63... ...
Both instruments, subsidies and direct financing of publicly financed R&D expenditures, are important means of sustaining balanced output and productivity growth in the manufacturing sector, but current R&D tax policy should be reexam~ned to increase its effectiveness in promoting private investment in technological innovation diffusion. ACKNOWLEDGMENT The support from C.V.
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From page 64... ...
" Paper prepared for the National Bureau of Economic Research Tax Policy Conference. Washington, D.C.
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