Analyzing the Impact of R&D Tax Incentive Policy on Firm Innovations in OECD Countries

Abstract

R&D tax incentives have gained popularity among the OECD countries as a means to improve innovation. However, the impact of R&D tax incentives on innovation has not been commensurate with the tax incentives given. This study aims to analyze the role of R&D tax incentives on firm innovation. Data on innovation and government support in 16 OECD countries was drawn from the Global Economy (World Bank Data) database. Three estimation techniques, Pooled Ordinary Least Square (OLS) regression analysis, Fixed effect and Random effect models are employed in estimating the relationship between R&D tax incentives and firm innovation. The first hypothesis found that tax incentives directly improve firm innovation, hence tax incentives are a significant policy tool in OECD countries, encouraging firms to invest more in R&D activities. The second hypothesis is rejected. The third hypothesis found that R&D tax incentive is displaced by R&D intensity in full sample analysis but not in groups with high innovation performance. The study proved the importance of skilled R&D personnel in maximizing the benefit of tax credits. The capacity of R&D personnel can complement to R&D tax credit for innovation performance support schemes by the government. The study's findings indicate that while R&D tax incentives are a strong indicator of a firm's innovative activities, they tend to overshadow the R&D intensity. However, this is not observed in countries that exhibit high levels of innovation performance. The study concludes that even though R&D tax incentives are a great predictor of firm innovation, R&D tax incentives are crowded R&D intensity but not in the case of high innovation performing countries. Policymakers should consider investing in human capital such as education and training to enhance the effectiveness of R&D tax credits in OECD countries.