31/3/2013: R&D and tax policy: income tax or targeted tax credits?

And while we are on innovation vs policy topic, here's another interesting study, looking into policy drivers for R&D. Ernst, Christof, Richter, Katharina and Riedel, Nadine, "Corporate Taxation and the Quality of Research and Development". CESifo Working Paper Series No. 4139, February 2013.

The paper "examines the impact of tax incentives on corporate research and development (R&D) activity. Traditionally, R&D tax incentives have been provided in the form of special tax allowances and tax credits. In recent years, several countries moreover reduced their income tax rates on R&D output.

Previous papers have shown that all three tax instruments are effective in raising the quantity of R&D related activity. We provide evidence that, beyond this quantity effect, corporate taxation also distorts the quality of R&D projects, i.e. their innovativeness and revenue potential.

Using rich data on corporate patent applications to the European patent office, we find that a low tax rate on patent income is instrumental in attracting innovative projects with a high earnings potential and innovation level. The effect is statistically significant and economically relevant and prevails in a number of sensitivity checks. R&D tax credits and tax allowances are in turn not found to exert a statistically significant impact on project quality."

All is fine, folks, but what does one do when the two countries compete for R&D projects allocations in the environment where both have already set zero tax on patent income?