R&D Tax Incentives as an Alternative to Targeted R&D Subsidies

Governments can provide targeted R&D subsidies and/or tax incentives to spur innovation and growth in the business sector. This chapter analyzes the theoretical pros and cons of these policy instruments and their practical implications according to the empirical literature. Tax incentives have low administrative costs, enable market agents to choose R&D projects, and can be provided to many firms. However, they entail the risk that governments might finance R&D that would have been undertaken anyway (deadweight loss) and that firms may relabel other costs as R&D costs. Targeted subsidies are preferable for projects with high uncertainty and those that require a long time to achieve a finished product and for contexts in which the government wishes to allocate resources to specific sectors. However, such subsidies have high bureaucratic costs, distort competition, and favor grant application experts. The greatest disadvantages of targeted R&D subsidies are that they are mainly allocated to large firms and are often used as covert industrial subsidies.