Where is the productivity benefit in R&D tax credits?

New research into innovation gains calls for a rethink of industry support

As arguments rage over the Australian government’s cuts to research funding – both actual and mooted​– there is at least some good news for research agencies and universities. 

A new study, examining the impact of investment in research and innovation on Australian market sector productivity, reveals the government gets more bang for its buck from investing public money in research agencies and universities than from the almost A$2 billion in R&D tax concessions it presently provides to industry.

In fact, the paper’s authors – ​Kevin Fox​​, a professor of economics and director of the Centre for Applied Economic Research ​​at UNSW Business School,​​ along with postdoctoral research fellow Amani​ Elnasri – ​find no evidence of any productivity benefit from indirect public support, such as R&D tax concessions for the business enterprise sector, nor from support for civil sector or defence R&D.​​​

Perhaps bravely, Fox has been presenting his findings to “multiple industry forums all over the country”. He notes two different reactions.

“One is that industry relies on these R&D tax credits,” Fox says. This line of argument brands his evidence as ‘too flimsy’ and claims that by ‘saying [credits] don't matter and the government could remove them … this is going to put us out of business and you should just shut up’.

“Another view is: ‘I don't know what these people are complaining about, we never viewed the R&D tax credit as being core to our business, we just treat it as an end-of-financial-year bonus.’ That was probably not what the government wants to hear, though it may suspect that's what many companies view the R&D tax credit as,” Fox says.

Successive governments have redesigned the tax credits scheme, indicating concern that the system is being rorted. 

Says Fox: “Talking with management consultants, they give me examples of various companies. Such as a mining company that built an access road and called it R&D, so it could claim a tax credit for that.

“Universities and research agencies such as the CSIRO have to justify how they use public funding, such as through peer review of research grant applications. Often with universities it's block grant funding based on documented past research performance. Whereas with the business R&D tax concession, while there are rules and the possibility of an audit, the companies are allowed to self-declare activities as R&D.”

New policy goals

Fox hopes the research results may help government rethink the way it supports industry.

“I can give many reasons why public spending on the R&D tax concession may actually lower private sector productivity,” he says. “And that includes things such as that it allows small firms to exist. And so new firms come into the industry and they typically have lower productivity than incumbents. So if you look at overall productivity, it will go down.

“But you actually want these new entrants coming in because they may be more productive, or simply more profitable, than the incumbents in the future. They bring in new products, services and ideas that can enhance welfare, and this is all good. So, there are reasons I can give why the R&D tax concession may still be beneficial, but if your policy goal is just to raise productivity, then that may not be the most effective way of doing it.

“Rather than spending A$2 billion a year on R&D tax credits, if raising productivity is the policy goal then it may be better to look at funding schemes that could strengthen the connections between business and universities.”

'Our research asks for a better response from industry regarding why the R&D tax concession should be preferred to other types of industry support'

KEVIN FOX

UK research and self-interest

​Fox and Elnasri began their research in 2012 as part of the then Gillard government’s Securing Australia’s Future initiative. The paper was a component of a project by the Australia Council of Learned Academies, which was asked to report on the role of science, research and technology in lifting Australia’s productivity. 

Fox credits motivation from a study in the UK, conducted after the global financial crisis when the UK government was looking at financial austerity measures and had its eye on axing the science budget. 

“That study is credited with helping to save the UK science budget by providing evidence that shows what matters for our future prosperity is productivity, and if you cut the R&D budget for science you're killing off our future prosperity,” Fox says.

Fox and Elnasri’s work also plays into an ongoing policy tension between allocating funding to targeted applied research – that is, further examination of what we already know – as opposed to pure research which may make new discoveries. 

So isn’t it a little convenient that academics such as Fox and Elnasri should come down on the side of universities?

Says Fox: “You’re right, this whole issue of coming from a university [and saying] stop giving money to business and give it to us, you could say there's a bit of vested interest there. But the same goes the other way. At least I've got statistical evidence which backs up my argument, whereas industry typically says, 'you don't understand’.

“At a minimum, our research asks for a better response from industry regarding why the R&D tax concession should be preferred to other types of industry support."         

Has innovation dried up?

​Australia's productivity performance has slowed “compared with the golden age we had from the mid-to-late 1990s into the early 2000s”, Fox notes.

Other industrialised countries are in the same boat, giving rise to global debate about whether innovation has finally dried up. Have all the big inventions been made and from here on it’s just tinkering around the edges? Or is it that Western "economies today lack the spirit of innovation”, as Nobel prize-winning economist Edmund Phelps sees it? Fox is not so alarmist.

“We are revisiting a debate that took place in the late 1970s and early 1980s when the same thing happened,” Fox says. “Productivity growth dried up and people said, ‘Well, was that it? Was that the postwar productivity boom and now we're just going to have to expect lower productivity growth and therefore lower growth in the standard of living?’ 

“[At that time] the US economy and other economies were suffering from stagflation – they had high unemployment, high inflation rate and the economies were basically stalled. Companies were not investing in new innovative activity due to uncertainty arising from the economic environment, and when the economy picked up they did invest and away we went. The benefits of investment in hi-tech capital finally appeared and then there was all the productivity from that.” 

But since the global financial crisis of 2008, many firms appear cautious and are not investing in R&D as they have in the past.

“It appears that a lot of firms are carrying a lot of cash, which is unusual. The ABC reported earlier this year that cash balance holdings of Australian firms were now A$111 billion. That’s a lot of money lying around, money that would previously have been put to productive use – investing in R&D, investing in new assets, and so on. That seems to have stalled due to the uncertain business environment,” Fox says.