R&D tax incentives and innovation: Examining the role of programme design in China

Abstract

Successful tax incentive interventions rely on effective programme design, yet designing an effective programme is highly challenging. We draw on the policy design and tax incentive literature to shed light on how two policy design choices – the nature and targeting of the incentive - shape the innovation effectiveness of a high- and new-technology enterprise tax incentive programme in China. We first find evidence that, on average, the programme can stimulate increases in firm R&D and patenting. Not all firms benefit equally, however. Second, we find that firms with larger incentives experience greater innovation impacts, but that high incentive values may crowd out R&D. We also find multiyear incentives to be effective for stimulating firm innovation in all years, but only in the initial years for R&D. Finally, for targeting, following a ‘picking winners’ strategy may enhance programme effectiveness as we find stronger innovation impacts for firms with greater programme experience, certification likelihood, and innovation experience. Our study contributes by helping resolve the theoretical ambiguity about how policy design choices about tax incentives' value, duration, and targeting can impact innovation effectiveness, by providing insights on the effectiveness and heterogeneity of the innovation impacts of tax incentives in emerging economies, and by providing more explicit guidance on how to design tax incentive programmes to raise R&D and innovation.