Tax Incentives of R&D

It is popular to promote private R&D investments with tax credits or tax allowances in the OECD countries. This report depicts the justifications and criteria presented in economic literature, which should be used when decisions about tax incentives are made. The main argument is that firms do not consider all the social welfare gains, when they decide about an R&D investment. Another linked justification is that the production based on the innovation may be too small, because the firm must finance the sunken costs generated both by the failed and the successful trials, and sell with a price that is higher than the marginal costs. On the other hand, there are also negative externalities involved in R&D investments. Moreover, introduction of a tax incentive necessitates that the welfare gain generated is sufficient to cover the losses due to the marginal costs of public funds, which appear due to the lost tax revenues. The report concludes that there are well-founded theoretical reasons for promoting private R&D investments with public funds, but the optimal scale and the best methods, such as choice between direct support and tax incentives, are questions to be solved by empirical studies.