Do Tax Credits Stimulate R&D Spending? The Effect of the R&D Tax Credit in its First Decade

This paper examines the impact of the R&D tax credit between 1981-1991 using confidential IRS data from corporate tax returns. This paper makes two key advances on previous work. First, this paper implements a new instrumental variables (IV) strategy based on tax changes that directly addresses the simultaneity of R&D spending and marginal credit rates. Second, it makes use of new restricted-access IRS corporate return data describing R&D expenditures. Estimates imply that a ten percent reduction in the user cost of R&D leads the average firm to increase its research intensity—the ratio of R&D spending to sales—by 11 percent in the short-run. Long-run estimates imply that firms do face adjustment costs and further increase spending over time. Analysis of the components of qualified research shows that wages and supplies account for the bulk of the increase in research spending. Comparisons of the elasticity across firms of different sizes, industries, tax status, multi-national status and credit history are also made. Long-run and retiming analyses show no evidence that firms allocate their qualified research spending over time to maximize their R&D tax credits. Elasticities of qualified and total research intensities from a smaller sample suggest firms respond to user cost changes largely by increasing their qualified spending, meaning that the type of R&D the federal credit deems qualified research is an important margin on which the credit affects firm behavior.