Tax Incentives Boost Innovation

Research funding via the tax system has a positive effect on investment in innovation projects. This is the finding of a metastudy conducted by the ifo Institute that summarizes findings on quantitative evaluation studies in Europe, Japan, Canada, China, Australia, and the United States. “Germany has been operating this type of funding since 2020. Because it generates much less bureaucracy, it is of particular benefit to small and medium-sized enterprises,” explains Oliver Falck, Director of the ifo Center for Industrial Organization and New Technologies.

In the study, success was most evident in those countries that incentivized research and development expenditure through the tax system, for example by offering tax credits or special depreciation options for material or personnel costs. The authors write that compared to direct project funding, tax incentives have considerable advantages that can be of particular benefit to small and medium-sized enterprises (SMEs): “SMEs that receive support through the tax system are spared the effort of submitting elaborate applications and the cost of expensive consulting services to help them do it. That’s why, with Germany’s new R&D tax credit, it’s important to keep the process for obtaining the tax credit as simple as possible from the outset and to review it regularly,” Falck recommends.

The report also highlights the importance of general taxation for private-sector research and development activities. “The finding that lower corporate taxes tend to lead to more private-sector innovation is particularly important for Germany as a high-tax country in international comparison and should be taken into account in future tax debates,” Falck says.

This article is the fourth in the series on the reform program for tax policy, in which experts from the ifo Institute present proposals on how Germany can make its tax system growth-friendly and fair – from income tax, tax incentives for innovation and investment, and taxation of corporate profits to taxes on inheritance and wealth. The complete series will be published in ifo Schnelldienst on October 11, 2021.