The Senate Economics Committee will deliver its Report into the Morrison Government’s proposed changes to the R&D Tax Incentive (RDTI) in August 2020. A key aspect of this Report will relate to the proposed R&D intensity test for companies with >$20M annual grouped revenue. The analysis below finds that the proposed R&D intensity test has no solid intellectual or empirical foundation. On this basis alone it should be scrapped.
The core findings of the 2016 Review into the RDTI (the Ferris Review) which introduced the idea of an intensity test and the weaknesses of that analysis are reviewed below.
Core findings of the Ferris Review
The Review found that:
- The RDTI motivated claimants to spend on average an additional 14% on R&D compared to those who do not claim the RDTI. For every $1 of tax revenue forgone, claimants generated between $0.50 and $1.90 in additional benefit. Labour costs account for 60% of the increase in R&D expenditure.
- The RDTI did not generate spillover benefits beyond those appropriated by the individual claimant and did not significantly increase collaboration between industry and (public) research institutions.
- The RDTI should target early stage companies, high-potential new entrants (the loss-makers) – and existing companies operating in markets, often export markets, where R&D is a key aspect of competitive rivalry (so-called ‘R&D intensive’ companies). These companies are said to make the most efficient use of R&D resources and demonstrate higher additionality.
The Ferris Review has several main weaknesses:
- Additionality is a measure of incremental short-term impact on the quantity of R&D spending. Whilst this is the intent of the RDTI program it is not an appropriate measure of its success. The purpose of R&D spending is to launch new products or implement new processes that lift revenue or reduce cost. The effectiveness with which companies can translate investment in R&D into revenue is a better test of the utility of taxpayer investment in R&D. In this context, success means revenue, margin, and cash flow growth over time.
Common sense suggests additionality will be highest for loss-making companies. It is also true that 80% of loss-making and early stage companies fail within 4 years. Companies that fail waste taxpayer funding and generate zero spillover benefits even if short term additionality is high. Conversely, ABS Research shows that R&D active companies report higher revenue growth, profit growth, export growth and collaboration than companies that do not undertake R&D. Growing companies deepen and extend supply chains and generate economic and employment multipliers (spillover benefits).
Time series analyses to calculate the economic benefit of the RDTI, in terms of success, would generate more useful analysis. The Ferris Review made this suggestion and recommended further analysis of ATO and ABS data, and that the ABS and/or AusIndustry supplement its business R&D survey / Registration processes with evaluation questions. This has not yet been done.
- The proposed R&D intensity test presumes that companies spending more on R&D are likely to generate higher additionality than those that spend less. This is self-evident, but says nothing about the likely success of the R&D compared to lower spend and (by inference) more incremental product or process R&D.
Research already shows that lower cost incremental R&D is likely more successful and no less additive to competitive advantage than higher cost more breakthrough R&D. Time series analysis rather than assessment of additionality would provide a more nuanced perspective. Equally importantly R&D intensity says very little about the quality of R&D undertaken. The Review asserted that higher spending on R&D is more likely reflective of activity on the technology frontier. This is questionable.
- The Ferris Review did no detailed qualitative work to understand the R&D ecosystems claimants or groups of claimants have developed to support innovation or how the RDTI is used efficiently within these ecosystems. To this extent, it understates the spillover benefits of the RDTI.
The Review found no evidence that the RDTI has much impact on industry-public research collaboration. The Review survey found Universities are bureaucratic, slow to deliver, and are unduly focused on securing IP rights. University engagements are expensive because they price up to capture part of the RDTI benefit companies claim.
For its part, industry is generally focused on applied R&D (product development) and does not consider University / public research institutions better equipped or experienced in this area than the private sector. The RDTI cannot solve this disconnects, even if one adds a RDTI collaboration premium.
What is the best way to target growth of the RDTI?
Do the analysis and define the right measures for success of the RDTI.
Define tighter and simpler RDTI access boundaries. A new R&D intensity test based on an income tax scale – type system replete with complex calculation and boundary distortions is not needed to achieve this outcome. Large R&D projects of any type (perhaps excluding clinical trials) should be subjected to the rigour of competitive assessment in grant programs rather than accommodated in a self-assessing scheme like the RDTI.