R&D Tax Credit: Options for Repeal or Modification
If there are externalities associated with certain activities, there is an economic case for providing a concession for these activities from the BBLR framework. If, for example, firms undertaking R&D fail to capture all of the benefits, then left to their own devices, they may undertake an inefficiently low level of such expenditure. However, the 2001 Tax Review commented that externalities are pervasive and it is generally impossible to measure the size of the relevant external effects of intervening government measures. Therefore, deviations from a broad base low-rate approach should be made only when a substantial burden of proof is discharged.
OECD tax recommendations in respect of New Zealand are mixed. The 2007 working paper on the taxation system in New Zealand recommended limiting exceptions to the corporate tax base by removing the current preferential tax treatment for certain activities or industries and resisting the introduction of new tax concessions. However, the 2007 review of innovation policy identified the absence of larger tax incentives as a notable weakness.
Information on whether there is underinvestment in R&D in New Zealand relative to other countries is mixed. OECD comparative data indicates that the ratio of business R&D to GDP is low. However, recent work indicates that levels are higher than can be expected for countries with similar characteristics to New Zealand and that business expenditure on R&D may have been under-reported because of survey design (by about 65% in 2006).
Tax credits for expenditure on R&D have applied from the 2008-09 income year. Businesses conducting eligible R&D can claim a 15% refundable tax credit in respect of that expenditure. However, there are some concerns around the R&D tax credit. The first of these relates to the estimated fiscal cost of maintaining the credit, being $373 million per annum from 2011/2012. There are also concerns about the effectiveness of the credit. The aim of the credit was to generate additional R&D, thereby increasing productivity in the economy. However, given international experience, and anecdotal evidence, the government is concerned that little additional expenditure will be generated as a result of the credit. There are two principal causes of concern: firstly, firms can claim the credit on pre-existing R&D investment plans, and secondly, recharacterisation of expenditure (to fit the eligibility criteria) may occur. Research in Australia has shown that expenditure claimed under the Australian equivalent of the R&D tax credit contains a significant element of recharacterised expenditure. There is clearly a risk that this may occur in the New Zealand context. In addition, the credit involves significant compliance costs for firms and their advisors in preparing returns and in determining which expenditure is eligible for the credit.
Given the above concerns, and the significant fiscal and compliance costs involved, the credit may not be justified by a sufficient increase in R&D investment.
There are alternatives to repealing the R&D tax credit in its entirety. These include reducing the scope of what constitutes ‘eligible expenditure' and the rate of the refundable credit itself. However, these options were not preferred as they still entail a significant fiscal cost and they do not address the concerns around whether the credit will be effective in encouraging new R&D investment. The efficiency gains from applying the revenue towards personal tax reductions are considered superior to any gains derived from the continuation of the R&D tax credit in a modified form.
