The After-tax Marginal Cost and B Index of the R&D Tax System in Japan

As of the 2024 fiscal year, Japan's R&D tax credit amounted to 763.7 billion yen, which is equivalent to approximately 5% of corporate tax revenue and the largest loss of tax revenue among special tax measures. Nevertheless, the R&D tax credit is still necessary because there is a positive externality in firms' R&D activities; even if results are produced, there is a public goods-like characteristic wherein they are free-ridden. Thus, if left to the market mechanism, firms' R&D activities will be underestimated. Information asymmetry, uncertainty, and the need to secure funding for R&D activities might also arise. While it is possible to support R&D activities through subsidies or other policy measures, the R&D tax credit has a lower application cost than subsidies requiring advanced applications and post-event reporting of results, thus offering greater benefits to firms. However, as this causes a significant loss in tax revenue, there is a great deal of interest in the results of the R&D tax system, which has led to many empirical analyses on this topic. Subsequently, this study comprehensively surveys previous empirical analyses of Japan's R&D tax credit system and highlights the importance of analyzing the system from the cost of capital perspective. I then present a model of firm behavior that incorporates the R&D tax system, derives the cost of capital, and theoretically examines the after-tax marginal cost of R&D and the B index. Finally, the results obtained from estimating the after-tax marginal cost and B index based on Japan's R&D tax system demonstrate that Japan's system favors small and medium-sized enterprises over large firms.