R&D tax incentives and innovation: evidence from manufacturing firms in India

Abstract

This thesis contributes to the long-standing and ongoing debate on the effectiveness of R&D tax incentive schemes on firm innovation activity. It focuses on the impact of R&D tax credit scheme in an emerging country context such as India. The existing literature on R&D tax credit has largely focused on developed countries. In emerging country context, there are few overviews from China (Guo et al. 2016; Wang et al. 2017) and Taiwan (Yang et al. 2012), but the market environment and regulatory framework in these economies are much different from that in India. For instance, India spends 0.7-0.8% of R&D expenditure as a percentage of GDP compared to 1.8 % in China. In 2016-17, the private sector accounted for only 42 % of total R&D spending in India, as compared to 60-70 % in China (World Development Indicators; R&D statistics 2017- 19, DST India). Mani (2010) has estimated the elasticity of R&D expenditure with respect to tax foregone due to the R&D incentives in India for a shorter period (2002-2006) and has not addressed the concern of self-selection into the program. Moreover, empirical evidence on the effect of the R&D tax credit scheme in India is also much required as India’s private-sector R&D spending has increased in recent years, while the forces driving this change have remained widely unexplored. R&D tax credit scheme was introduced in India to promote private in house R&D investment and firm innovation during 1999-2000. In the period spanning 2001–2010, the policy offered weighted tax deductions of 150% for any capital and revenue expenditure incurred on in-house R&D by firms in select sectors. The country’s R&D tax deduction was increased to 200% in the fiscal year 2010-11, and the eligibility was extended to firms in all sectors in 2009-10, placing India among the select few countries providing “super deduction” for investment in R&D, along-side an already generous tax regime for such investments. Based on the above discussion, the thesis has the following objectives: 1. To investigate the impact of R&D tax credit scheme and its reform (2010-11), that increased the weighted tax deduction from 150 % to 200%, on the innovation activity of the firms. 2. To investigate the impact of R&D tax credit reform (2009-10), that extended the provision of the tax credit scheme to all manufacturing industries, on innovation activity of the firms. This study considers the impact of R&D tax credit scheme on firm innovation input in the form of R&D expenditure and R&D intensity, and on firm innovation output in terms of the number of patent applications at IPO and USPTO. The inclusion of innovation outcomes accounts for the issues of unproductive and re-labelling of R&D activities for an effective evaluation of the R&D tax credit scheme. The traditional R&D policy evaluation approaches have largely ignored the endogeneity problems along with the issue of selection bias in the estimation process (David et al. 2000), this study employs appropriate econometric techniques with consideration of the selection bias and endogeneity issues.