Chapter 4
Criteria for Evaluating R&D Assistance
4.1
Two key concepts in evaluating schemes to support R&D are
public
spillover benefits and
additionality.
4.2
These concepts are reflected in the objects clause in the bill, which
explains that the goal is:
...to encourage industry to conduct research and development
activities that might otherwise not be conducted because of an uncertain return
from the activities, in cases where the knowledge gained is likely to benefit
the wider Australian economy.[1]
Public spillover benefits
4.3
As the EM notes, 'innovation is recognised internationally as an
important driver of economic growth'. But this is not in itself justification
for tax incentives or other taxpayer support for it.
4.4
Companies will engage in R&D that they expect will generate a good
return in terms of increasing their profits. Much of this R&D will result
in incremental improvements in their goods, reductions in their manufacturing
costs, or an addition to their product range such as a new flavour. But there
is no reason for the taxpayer to subsidise such activity as the benefits will
accrue totally and solely to the companies involved.
4.5
The case for taxpayer subsidy only arises when a company's R&D leads
to benefits that partly accrue to those outside the company and for which the
company is not rewarded; a 'spillover benefit' (or 'positive externality').[2]
4.6
The idea is much like that expressed by Thomas Jefferson:
He who receives ideas from me, receives instruction himself
without lessening mine; as he who lights his taper at mine receives light
without darkening me.[3]
4.7
The social benefits of the R&D then exceed the private
benefits. This sort of R&D is likely to be undersupplied as for some
projects the private costs will exceed the private benefits but be less than the
social benefits. A payment (or tax concession) to the company to encourage its
R&D may then make everyone better off.
4.8
The idea of spillovers is important in the 'new growth theory' in the
economics literature. A survey article concluded:
...the overall impression remains that R&D spillovers are
both prevalent and important.[4]
4.9
Medicines Australia gave an example of a spillover benefit from their
R&D that accrues to the community rather than to other companies:
...it provides early access to the Australian community to new
medicines through being in a clinical trial. If we were not doing those
clinical trials here with new medicines, the community would have to wait until
that medicine is registered and marketed in Australia. Also, through running
clinical trials for thousands of patients around Australia every day the
pharmaceutical company is paying for their health costs by being in a clinical
trial...[5]
4.10
The Australian Industries Group supports the spillover principle:
Ai Group agrees that the case for public support of business
research and development activity arises because of the direct and indirect
spillovers that arise when the full value that flows from this expenditure is
not captured by the businesses making the expenditures but part of which flow
to other parties. Without public support, the total quantity of business
expenditure undertaken would be less than the socially optimum level.[6]
4.11
The Department of Innovation, Industry, Science and Research referred to
spillover as the justification for support at Estimates:
There are very substantial benefits that we have talked about
in actually doing the R&D. There are very substantial spillovers from doing
that, and that is what gives an economic justification for providing support to
it.[7]
Additionality
4.12
Another criteria for an efficient incentive scheme is 'additionality'. A
good scheme will be focused on generating additional R&D rather than just
making payments to companies for R&D that they would have undertaken
anyway.
4.13
The concept of additionality is accepted by most experts:
By providing an incentive, the government stimulates a level
of expenditure beyond that which the primary businesses would otherwise
undertake...[8]
Additionality is an important concept in public finance,
addressing the issue of whether public support is resulting in new activity
rather than substituting for private support that would have occurred in the
absence of the intervention.[9]
Thus, spillovers are only a relevant rationale for public
support when subsidies change the private decision about whether to proceed
with an investment.[10]
4.14
The Minister for Innovation, Industry, Science and Research explained
that additionality is an important reason for the changes to the scheme
incorporated in the bill:
I met with some senior executives of a very large corporation
and they explained to me, ‘We do not make our decisions based on whether or not
we are going to get a tax benefit. We make our decisions on a business case,
given the scale of the projects that are involved. Once we have made the
decision, we send the claim down to our accountants to clean up and submit to
the government for a benefit.’ Under the present regime, why wouldn’t you? What
we are trying to do is directly affect the way in which decisions are made.
That is why we have tailored it to be of direct benefit to those companies
where the sort of benefit that we can provide through the scheme will make a
substantial difference to the companies as to whether or not the work is
undertaken. That is the philosophy behind this. We want to make a big
difference, we want to change behaviour and we wanted to change attitudes. The
judgment call that I have made, based on the evidence that I have seen, is that
this is the sort of thing that can affect the way companies do business.[11]
4.15
One of the few to argue against it is a major beneficiary of the current
scheme, the advisory firm Michael Johnson Associates (MJA):
I think one of the great concerns about the idea of additionality
is that people keep focusing on: ‘Prove that we are only funding things that
would never have been done.’ That does not make sense to me. What the credit
can do is help reduce the effective cost of the R&D that companies are
doing—the priorities, not the marginal projects, that they should be doing.[12]
4.16
MJA did not explain why they thought taxpayers should make this gift to
companies which does not result in any additional R&D.
Assistance to larger versus small companies
4.17
Based on these two criteria it is generally thought that assistance to
smaller companies is more likely to be preferable to assistance to larger
companies. Many original ideas start out in small start-ups.
4.18
Professor Green commented:
I do support the move to something like dominant purpose and
also that ventures should be innovative and risky. I think that is essential to
getting those smaller companies out on the cutting edge that wish to
participate.[13]
4.19
He added:
I would certainly be one of those who would advocate that
some of those larger companies that have accessed resources on a habitual basis
in the past may have to lose some of that in order that newer companies with
newer ideas can access it. I think that is just a point of principle.[14]
4.20
A recent UK study argued that R&D assistance there should be:
...refocused to those companies where the barriers to a
sustained R&D programme are greatest and the potential spillovers to the
rest of the economy are greatest. That means high tech companies, small
businesses and start-ups.[15]
4.21
The Department of Innovation, Industry, Science and Research has
referred to other analysis:
The OECD has also done a lot of work on where the greatest
benefits from research and development incentives are based. Their research
also points to the fact that greater benefits are derived from providing
incentives to smaller businesses. That is at the heart of where our policy of
having a dual-rate system with a higher rate for small to medium enterprises
comes from.[16]
4.22
A tax partner from Ernst & Young remarked:
...once companies are profitable or are earning revenue out of
their R&D endeavours, there should be some limitations on the amount of
assistance government is providing. Companies need government intervention most
in the formative stages of any product or process development.[17]
4.23
Again a minority opposing view was expressed by Michael Johnson Associates:
To say that innovative companies are generally SMEs is an
assertion. I have not seen the evidence.[18]
4.24
Even if large and small companies were equally innovative in their
ideas, it is much easier for large established companies with large retained
earnings and easy access to finance to fund their ideas. It is much less of a
gamble to undertake a risky project if it only represents a small proportion of
a large diversified company's capital than if it puts at risk a large
proportion of a small company's capital. There are therefore more good ideas
that are not undertaken due to financial constraints by small companies and so
assisting them is more likely to result in additional innovation.
4.25
Another important difference between large and small companies is that
new start-ups typically do not make profits in their early years so that they
cannot benefit from tax concessions. This point was emphasised to the Committee
by AusBiotech:
Cognisant of the unique business model required by
biotechnology, where significant funds are required often over many years and
up-front before any return can be realised, the tax credit, especially the
refundable credit, is vital if innovations and the start-up biotechnology
industry are to thrive in Australia...Start-up innovation companies applauded the
government’s policy announcement to move from the tax concession, which is not
working for the industry as a whole, to the tax credit that will provide a
much-needed lifeline.[19]
4.26
The Cutler Review concluded that tax concessions appeared to influence
the behaviour of small companies more than large companies:
The inducement effects of a concession are likely to differ
as between small technology based firms, and larger more mature firms. At one
consultation with larger companies, 82 per cent of those present indicated,
when polled, that the incentive value was marginal or none, and no one said the
175 per cent incremental premium scheme influenced their R&D activity...At
the other end of the spectrum, the introduction of the Tax Offset element of
the Concession for small tax loss firms has been highly successful...[20]
4.27
Treasury emphasised smaller firms when describing the aims of the bill:
Its overarching aims are to increase support for all R&D
companies, to encourage more small and medium sized companies to do R&D... The
tax incentive is expected to induce more R&D for a number of reasons. It
tilts support to small and medium businesses...[21]
Assistance for research versus development
4.28
It is more likely that research will lead to spillover benefits than
development. And the more 'experimental' is the research, the more likely it
will lead to insights with applications outside the business of the company
undertaking it. The original idea with wider ramifications is more likely to
arise from basic research than process improvements.
4.29
This view seems widely supported:
...there are potential benefits from public support for more
basic or strategic research, where the returns can be difficult for an
organisation to adequately appropriate.[22]
...one might expect few spillovers from applied work, that is,
putting a particular idea into productive form.[23]
The strongest case for public support based on spillovers
occurs for basic research...[24]
Radical innovation is also linked with spillovers much more
strongly than incremental innovation.[25]
4.30
There are some who question this:
No evidence has been presented throughout this entire policy
debate that the public subsidy for new knowledge creation will yield greater
economic benefit than the subsidy of the application of that new knowledge to
the creation of new products, processes, services and devices. I believe that
this premise is fundamentally flawed.[26]
Grants versus tax concessions
4.31
R&D tax concessions are one form of government support for R&D.
Alternatives include the direct funding of research work by universities and
organisations such as CSIRO; and grants to companies, which could take the form
of profit-contingent loans.[27]
The tax concessions are placed within the context of total support for R&D
(interpreted broadly) in Chart 4.1.
Chart 4.1: Australian
Government Expenditure on Science & Innovation % to GDP
Source: Venturous Australia, 2008, p. viii.
4.32
An important difference between these various forms of assistance is the
extent to which the projects supported are those chosen by the companies
themselves or those selected by governments. As the House Economics Committee
put it:
Unlike grants, tax concessions apply to all R&D,
regardless of its quality. Views differ about whether this is a good or bad
thing. Those most sceptical about the ability of governments or their advisers
to ‘pick winners’, or judge which R&D is ‘high quality’, laud supporting
that R&D which companies themselves see as most beneficial. They
characterise the tax concession as ‘market driven’. Alternatively, others view
such tax concessions as ‘blunt measures with no quality control’ and argue that
firms are most likely to choose R&D that is of specific benefit to
themselves rather than to the broader economy. They also warn that some of any
apparent increase in R&D following the introduction of tax concessions may
reflect accountants (mis)classifying more expenditure as R&D, rather than a
true increase in research activity. They advocate requiring firms to compete
for more targeted funding of R&D likely to have wider benefits.[28]
Committee view
4.33
While the Committee sees merits in targeted loans with profit-contingent
repayments as either a supplement or alternative to tax concessions, it is not
directly related to the bill so is not considered further.
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