Wednesday 22 November 2017

Dan O'Brien: Close scrutiny needed as spending on R&D tax credits soars to €640m

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Dan O'Brien

Dan O'Brien

More than half a century ago, British Prime Minister Harold Wilson spoke with great enthusiasm about the "white heat of technology" and how the embrace of the scientific revolution would forge a "new Britain". The 1963 speech to his party's annual conference became famous for its articulation of the transformative power of science and technology. Few modern politicians anywhere would take a different view today. No economist would.

Becoming more prosperous depends largely on becoming more productive. That, in turn, depends a great deal on technological innovation. Inventing new things and doing things more efficiently are what makes each hour we toil more productive. Because the embrace of technological change is so important, governments everywhere have increasingly detailed and ambitious policies to promote it. And they spend considerable amounts of taxpayers' money to that end. Ireland is no exception.

A sizeable portion of the total spend on research and development (R&D) in Ireland comes directly from the Government's coffers. In the 1990s there was a significant ramping up of funding aimed - directly and indirectly - at boosting R&D. Post-2008, most areas of government spending were cut. Public R&D budgets of various kinds were not spared. Budget allocation fell by 20pc from 2008 to 2013, although there has been some recovery in recent years. Being the largest recipient of public R&D funds, third-level institutions were the hardest hit.

Looking to the future, the main plank of government R&D policy - called "Innovation 2020" - sets out a number of ambitious goals, including raising private and public spend to 2.5pc of GNP (currently 1.7pc), and almost doubling the number of employees and research students in the sector.

There will always be questions about the efficacy of spending in the area. Media Lab Europe, an expensive failure in the 2000s, comes to mind as an example of a serious and costly failure. Yet, like much of the research that gets funded, trial and error is part and parcel of the way innovation is encouraged. There is every sign that, despite some failures and waste, Ireland will follow the international trend in doing more at government level to encourage and support business R&D, as highlighted by a recent release from the OECD.

This can be in the form of direct funding (for example through agencies such as Enterprise Ireland and the IDA) or indirect measures (mainly tax breaks).

Tax incentives have become popular, as the chart shows. In 2016, 29 out of 35 OECD member states provided tax relief on R&D expenditure.

Public spending in the area in Ireland is fourth-highest among the 33 members OECD, equivalent to 0.36pc of GDP in 2014 and more than double the average across the group. Most of this is in the form of tax incentives - the total cost of tax breaks for R&D in 2014 (as a share of GDP) was the highest in the OECD. This is likely to explain, in part at least, why some companies' effective corporation tax rate is below the headline 12.5pc rate.

The government first introduced an R&D tax credit in 2004, allowing firms to offset expenditure against corporation tax or receive repayable credit. The scheme has since become more quite costly. The exchequer paid out €282m in 2012, €421m in 2013, and €553m in 2014.

And the surge does not appear to be abating. In response to a parliamentary question a few weeks ago, Finance Minister Michael Noonan revealed that provisional data indicated the cost would be in excess of €640m in 2015.

This is a lot of money. Have the incentives worked?

Certainly business R&D has grown. Overall spending has doubled in the past decade, with businesses ploughing over €2bn into innovation in 2014, the latest year for which figures are available. A good chunk of the increase went on human capital - employment in business R&D bucked the national trend post-recession, increasing from 11,000 in 2007 to 18,000 in 2014. (It should be said that both measures are likely to inflated by companies reclassifying spend and employee status to qualify for the credit.)

Last October, the Department of Finance released an economic evaluation of the tax credit*. The paper found it was "reasonably successful in its aim of increasing business R&D". About 60pc of R&D since 2009 was estimated to be additional expenditure, ie spending that would not have occurred without the tax incentive. However, 40pc would likely have happened anyway, meaning firms replaced their own financing with public funds, something economists call "deadweight loss".

Another issue is which kinds of companies benefit. Although indigenous firms have been increasing their R&D outlay, most of Ireland's innovation spending is imported. Non-Irish firms carry out about two-thirds of total business R&D, so they benefit most from the tax credit.

The European Commission, OECD and IMF have all said Ireland's R&D policy is too skewed towards tax incentives, suggesting more room for direct funding and perhaps targeted supports. Several countries have tax provisions that are specifically targeted at helping SMEs and young companies.

The truth is that there is no simple answer as to how to best use taxpayers' money to boost innovation. For instance, having bureaucrats decide which companies and projects should be granted funded has its problems in terms of expertise and cost.

Whatever happens, the issue needs to kept under close scrutiny, particularly as the costs of supporting business R&D are now so high, and continuing to rise.

Sunday Indo Business

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