R&D tax incentives
Governments worldwide increasingly rely on tax incentives to promote private R&D and innovation investment. They make eligible investments financially advantageous to firms, driving growth, but reduce governments’ direct tax intake. OECD monitors their availability, key design features, cost and impacts. This comparative evidence informs public and private decisions and underpins OECD’s policy advice to governments.
Key messages
Aiming to boost R&D performance by businesses and drive innovation and economic growth and social well-being, governments use the tax system to provide financial incentives for companies to invest in R&D. This additional investment in cutting-edge knowledge and its applications, which exhibit spillovers and high uncertainty, can provide benefits beyond those that the firms themselves can appropriate and can justify the subsidy.
While governments can also use other instruments such as targeted grants or contracts for R&D services, tax incentives have risen in popularity because they can be designed to let eligible companies choose which R&D projects to invest in. This makes tax support relatively easy to administer and compliant with trade and competition rules that constrain the use of state aid. However, a downside of excess reliance on R&D tax incentives is the reduced scope for targeting R&D funding to specific policy priority areas.
Countries differ in the extent to which they rely on tax measures to support R&D, and those that do design tax relief measures in substantially different ways. Key design features relate to:
- The scope and definition of R&D for tax purposes
- The choice of eligible R&D expenditure and tax instrument
- Provisions for firms with insufficient tax liability
- Provisions for the limitation of R&D tax benefits
- Preferential tax relief provisions for certain types of firms (e.g. SMEs), R&D activity (e.g. collaborative R&D) or R&D in specific priority areas (e.g. green R&D)
These design features influence the level of R&D tax subsidy available to different types of firms and the cost of R&D tax relief to government. They shape the extent to which firms can make use of tax benefits in the loss-making vis-à-vis profit case, and the degree to which specific types of firms such as SMEs, young firms, and start-ups benefit from a preferential tax treatment.
OECD analyses show that the effect of R&D tax incentives on business R&D investment tends to be more pronounced for small firms which, driven by their lower level of initial R&D performance, are on average more responsive to the availability of R&D tax subsidies than large companies.
R&D tax incentives and direct support measures are on average equally effective in stimulating business R&D investment, but they have different strengths. While R&D tax incentives are particularly effective in encouraging experimental development, direct government funding is comparatively more effective in stimulating basic and applied research. R&D tax incentives and direct funding measures therefore complement each other.
Effective monitoring and evaluation provide the basis for policy learning, prioritisation and improvement over time. As an integral part of innovation policy, they are crucial for demonstrating transparency, accountability and value for money in public spending.
OECD contributes to the monitoring and assessment of R&D tax incentives and direct government funding of business R&D through its development of dedicated data and analytical infrastructure on R&D tax incentives, enabling international policy comparisons and analysis. Moreover, it supports countries in their national evaluation efforts through the OECD microBeRD project – an internationally coordinated OECD study on the impact of R&D tax incentives and direct government funding of business R&D, in addition to country-specific, distributed impact analysis such as the 2023 OECD study on the R&D tax credit in Iceland.
Context
Tax incentives play a key role in the business R&D support policy mix
R&D tax incentives reduce the effective cost of doing R&D for firms and represent a key innovation support policy instrument in most OECD member countries and several other major economies. OECD estimates of government tax relief for R&D, when combined with data on direct funding (e.g. R&D grants and government procurement of R&D services), provide a more complete picture of governments efforts to promote business R&D and highlight generous R&D tax relief provisions compensate for relatively low levels of direct funding in several OECD countries. Tax incentives account on average for more than half of total (direct and tax) government support for business R&D in the OECD and EU areas.
Government tax relief for business R&D increased significantly in the past two decades
R&D tax incentives have become the pre-eminent instrument of support for business R&D. Over the past two decades, government tax relief for R&D expenditure as a percentage of GDP has exhibited persistent growth in both the OECD and EU-27 area. Both the increasing adoption and generosity of R&D tax incentives in OECD countries and EU countries over this period contributed to this upward trend. The increase in the aggregate level of R&D tax support in the OECD and EU-27 areas was only temporarily interrupted by the onset of the global financial and economic crisis which impacted the demand for tax support by firms as well as their ability to claim it. From 2011 onwards, the growth in the aggregate level of R&D tax support reverted to its positive trajectory in both the OECD and EU area but plummeted in the EU region following the outbreak of the COVID-19 crisis in 2020. Since 2020, the aggregate level of R&D tax support (as a percentage of GDP) continued to grow in the OECD area, while the level of this support remained constant in the EU area.
Tax subsidy rates on R&D expenditures have been increasing in the past two decades
Over the past two decades, the (unweighted) average rate of R&D tax subsidy per unit of R&D outlay increased in the OECD area for firms of all size, independently of their profit situation. SMEs benefitted from a higher R&D tax subsidy rate on average throughout this period. The (unweighted) average rate of tax subsidy on R&D expenditure rose across all four business scenarios with the increasing adoption of tax incentives from mid-2000 onwards, declined at the onset of the global financial crisis, and reverted back to its growing trend afterwards. While average R&D tax subsidy rates remained stable in the OECD area throughout the 2013-2019 period, they peaked in 2020 with the first-time launch of an R&D tax incentive in Germany and the enhancement of R&D tax incentives in several OECD countries following the COVID-19 outbreak. While some of the exceptional tax relief measures introduced following the COVID-19 were withdrawn in 2022 and 2023, estimated R&D tax subsidy rates rose again thereafter across all modelled scenarios, regardless of business size and profit situation.
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