Do R&D Tax Credits Improve Innovation Efficiency? Evidence from the 1981 U.S. R&D Tax Credit

• In Event: DSFI Session 4

Abstract

The United States (U.S.) government introduced its first tax credit for research and development
(R&D) expenditures in the Economic Recovery Tax Act of 1981 (ERTA). In this study, I
investigate the effect of the ERTA R&D tax credit on innovation efficiency, which I define to be
the ratio of patents or patent citations to R&D expenditures. More broadly defined, it is a
measure of how effectively firms convert research spending and existing human capital into new
patents, products or services. I find that the R&D tax credit reduced innovation efficiency, and
the effect is more pronounced for firms that can use the credit than for those that cannot. I
propose and test two mechanisms that could explain this reduction: 1) competition for research
resources and 2) over-investment in less promising projects. Empirical findings provide strong
support for the first mechanism and some evidence for the second.

Author

• Zhaochu Li, University of Oregon