4.3 R&D Tax Credits
Business expenditure on research and development (BERD) to develop and bring to market new technologies can give firms an important competitive edge. It can also make New Zealand more competitive internationally. There may be beneficial knowledge spill-over effects into the wider economy beyond those obtained by the firm that pays for the R&D. But because firms do not receive the full benefits of their investment, they may under-invest in R&D that would be beneficial to New Zealand as a whole.
This suggests there might be a role for government to provide assistance to encourage more BERD, and this scenario considers the effects of such assistance in the form of an R&D tax credit. However, tax credits are not free - the money must come from somewhere. In this case, it is assumed that there is a tax on households that covers the cost of the credits. This tax will affect the behaviour of households, including reducing their consumption levels (all else being equal). Balancing this is the knowledge spill-over effects of increased BERD, which are likely to act in the opposite direction. The overall value of the tax credits to the economy will be determined by whether the spill-over effects from the increase in BERD are large enough to outweigh the costs of the tax used to provide the credits.
However, R&D tax credits are difficult to model in a CGE framework because the link between the policy and the resulting impact on productivity is not clear and is not included in the model. This is the case even when the model includes R&D expenditure for each sector as ORANI-G does. Instead, the productivity impact or the growth impact needs to be determined outside the model, which can then be used to gain some understanding of the sectoral impacts. These impacts in turn will be determined by the level of spillovers, which again are limited in the model to the extreme cases of zero spillovers or perfect spillovers. With so much uncertainty in the inputs into the model, CGE modelling is much less useful in this scenario than in the other scenarios considered in this paper.
This scenario considers a 15% increase in BERD, which is assumed to arise from a 15% tax credit. This is based on the elasticity of BERD expenditure to R&D tax credits of 1%. It is a conservative value chosen from the range 0.05-2.0% estimated econometrically in the literature, and matches the long-run value of (Bloom, Griffith, & Van Reenen, 2002). The tax credit would cost $300 million, and generate an extra $300 million in BERD.
As with the effect of a tax credit on BERD, the effect on GDP of an increase in BERD has also been studied econometrically, with a wide range of results. However, the approximate mid-point of the literature suggests a 1% increase in BERD activity causes a 0.04% increase in GDP. Using these relationships, a 15% BERD tax credit (as assumed in the zero spillover case studied here) would result in a 0.6% increase in GDP. By putting this GDP increase into the CGE model, the productivity improvement that would cause that increase can be calculated.
