Entrepreneurs are likely to be vital to the economic recovery in the wake of covid-19, and the fortunes of startups have suffered enormously during the pandemic. New research from MIT suggests that an effective way of supporting the sector is via R&D tax credits, which helps to fuel high quality growth.
“What we see is an improvement in the environment for entrepreneurship in general, specifically for those growth-oriented startups that ultimately are the engine of business dynamism,” the researchers say.
The research found that when regions introduced R&D tax credits, they experienced 20% growth in new-firm formation over a 10-year period, with many of these firms of extremely high quality. By contrast, if the region introduced investment tax credits, this resulted in a 12% fall in firm growth over the same period.
“The investment tax credit arguably reinforces the strength of big business in these states, and that might create a barrier to entry for new firms,” the researchers say. “It might harm entrepreneurship. But the R&D tax credit facilitates knowledge, facilitates science, facilitates exactly the sorts of things that can spur new ideas, and spurring new ideas is the key for our entrepreneurial ecosystem.”
Supporting growth
The researchers relied upon 30 years worth of data on both company formation and startup quality, together with the Upjohn Panel Data on Incentives and Taxes, which has data on state tax policies.
By exploring the changes in business activity alongside any tax policy changes, the researchers believe they were able to understand the impact of the R&D tax credits on firm activity, both in terms of the number of firms created, and their general quality.
The main impact from the R&D tax credit appeared around three years after their introduction, with roughly 2% growth per year in the formation of high quality firms. This would endure through to the 14th year after the policy change.
“It takes a few years for that impact to make its way through the system,” the researchers explain. “If you expect a one-year payoff from this, that’s too short.”
Suffice to say, it’s not only startups that benefit from the R&D tax credit, and the researchers highlight the gains that larger firms experience too. Indeed, the researchers argue that historically, policy makers have focused efforts on improving innovation within large firms via this mechanism.
“The policy discussion has mostly focused on lowering the burden on, and providing incentives for, investment for big business,” they say. “Right now Amazon, for example, takes a very large R&D tax credit. And it can say, ‘Do you like your Amazon Echo or Alexa and your crowdsourcing services? Well, all that came from our R&D.'”
It’s a widespread benefit that the researchers believe renders R&D tax credits a useful way to stimulate growth in the post-covid economy, as the recovery will need to come from every corner possible.
The key, they believe, will be to restore business dynamism as much as possible, which will inevitably mean making it easier for new firms to form, and for those firms to become successful.
“The R&D tax credit is one of the few innovation policy instruments that at relatively low administrative cost, can make a big difference for spurring innovation and entrepreneurship within a region,” they conclude. “You have to be committed to it. You have got to be patient. But it does pay off.”
