Scrapping the R&D tax incentive is hardly a smart idea for economic policy

Cuts to the R&D tax incentives for Australian businesses - as proposed by the Business Tax Working Group - have significant implications for our future economic wellbeing. Image from www.shutterstock.com

The Business Tax Working Group discussion paper’s suggestion to reduce the R&D tax incentive reveals a clear-cut attitude to policy aimed at Australia’s economic development: “It’s all about the tax take.”

The point of having policies in support of R&D is to advance Australia’s economy and assist the ability of our firms in both producing new technologies and adapting and adopting technologies developed elsewhere. By doing this, it is presumed that Australian firms will be able to export advanced products and rapidly adjust to innovations from overseas.

The complexities of how R&D is transformed into economic benefits are simply ignored in the discussion paper. Fundamentally, the working group assumes that tax rates drive investment and innovation in firms, despite the paucity of evidence about this. Thus, they assume reducing tax rates will be more affective in creating an open, flexible and dynamic economy than improving the technological problem solving capabilities in the economy through encouraging R&D.

Why do firms do R&D? And how does this relate to the tax incentive?

The evidence shows R&D is more an intermittent activity than an ongoing one for most firms. Large ongoing corporate R&D labs are rare. Firms do R&D for a specific purpose: to update a product or process; to imitate competitors; or to work through a new innovation. They do this for many reasons, but mostly for competitive ones – if they don’t their competitors will take their market and so their profits.

The tax implications of these investment decisions are typically fairly low on the list of important decision factors. However, a better tax treatment does make justifications for R&D investments easier: a fact which partly drove the change from the R&D tax concession scheme to the R&D tax incentive scheme, as some large (typically mining) firms structured massive investments to reap the concession on investments that were legally R&D, but maybe won’t be under the new scheme.

That tax rates do not drive most R&D decisions can be seen in the reaction to the Howard government’s reduction in the old R&D tax scheme, where total R&D levels dropped then picked up to record levels over time. R&D incentives have an effect, but only at the margin. So we can assume a similar reaction will occur; a reduction in R&D spend followed by a slow increase as competitive pressures force firms to invest in R&D.

Does this matter? Yes!

This policy, and others supporting economic development, are not done to help individual firms. They are done to support a system. The more R&D done, the greater the skills and resources to do R&D - and the more firms learn to use R&D to improve their competitive position.

Australia has a low R&D spend comparatively, and R&D is the core of technological innovation. Technological innovation drives long-run economic development worldwide. Imagine our economy if we did not have cars or computer technology. The more firms doing R&D, the more likely they are to link with the public research system, and other area of low performance in Australia.

A general tax break may (or may not) support this ability to support technological innovation. Given most Australian firms’ low focus on technological innovation, it is likely that the system will be weakened. This matters because if R&D increases competitiveness, it should lead to more and better paid jobs and higher company earnings, thus increasing the tax take. The discussion paper appears to not take into account why we have an R&D tax incentive scheme in the first place.

To me, the most important thing this discussion paper shows is the government’s attitude to our economic development. We know from many studies that innovation drives growth and development. We also know that technological innovation is the key long term driver of economic development. Tax rates are neither here nor there compared to entrepreneurial attitude and the specialised resources required for R&D. Low taxes do not beat the ability to do something your competitors cannot do. Essentially, this discussion paper indicates the underlying belief that growth comes from low taxes.

So we have a proposal for future policy that excludes innovation and technological change, but assumes that lower corporate tax equals growth. However, as economies have become more developed their tax takes have increased from around 10% of GDP at the start of the twentieth century to 35-50% now. In general, growth rates have increased. Low tax rates do not drive growth!

The likelihood of cutting the R&D tax support scheme indicates the government’s attitude of neglect to what drives our jobs, incomes and lifestyles in the long run.