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Dan Lambeth works in financial services and is a specialist in commercial law, regulation and tax.

The upbeat New Year message on this site from Liam Fox reminded us all about the positive economic performance of our country and the exciting opportunities that lie ahead. Brexit provides the potential to boost the U.K.’s economic competitiveness and productivity.

Of course, there are a wide range of tools at the disposal of Ministers for boosting our economic performance over the coming years. As well as the promotion and financing of international trade and investment under Fox, the support of private sector research and development plays an important role, and successive Conservative governments have reaffirmed our Party’s commitment to science and innovation. In other countries, too, investment in innovation has grown significantly. China, for example, is now the second largest performer in the world in terms of R&D spending, and accounts for 20 percent of total world R&D expenditure.

Many countries, including Britain, provide incentives for R&D through the tax system. While they are often referred to as “tax credits”, internationally, they comprise a wide variety of measures, including credits, refunds, deductions and allowances. They provide an important source of indirect support for firms who may find it difficult to source finance and capital for innovation, especially at seed and early stages of business development.

SMEs, in particular, may find it difficult to access finance. Smaller businesses in the UK are responsible for over half of private sector jobs; therefore, it is important to support this sector of the economy. Tax incentives are also important for the economy because they enable firms to invest at socially optimal levels. In the absence of support, the private sector may not invest sufficiently in innovation as it can be difficult to fully appropriate the return on investment; the resulting knowledge may “spillover” to other companies and sectors.

Therefore, it is welcome that, in the last Budget, the Government announced an increase in tax relief for companies that carry out qualifying R&D. It is also telling that, at the same time, left-wing critics called for the abolition of R&D tax credits. Interestingly, the political debate over R&D tax incentives has come to symbolise much of what differentiates Conservatives from the Left: robust policy based on evidence that supports free markets, versus dogma based on statism that threatens to damage our economy.

But in spite of the opposition of the Left, there is growing econometric evidence that tax incentives for R&D work. Several recent studies show that reducing the user cost of R&D through the tax system leads to an increase in research intensity. But why let hard econometric evidence get in the way of policy making?

Furthermore, the private sector understands the needs of the market better than government officials. Bureaucrats and apparatchiks are not qualified to pick commercial winners and losers, as demonstrated by the economic mismanagement of the 1960s and 1970s. Direct support and investment for specific projects and institutions can play a useful role in the economy. Indeed, under the current Conservative government, companies may apply for a wide range of funding opportunities, including grants for advanced nuclear technology, sustainable energy, manufacturing and healthcare, as well as tax incentives. However, the Left’s insistence on the exclusive use of public subsidy and the abolition of tax incentives reminds us, if ever needed, of the Left’s centrist controlling tendencies and dogmatic preference for the public over the private. Governments are not well placed to decide on the most socially optimal projects and the administration of such schemes can be costly.

Therefore it is right that tax incentives for R&D should make up the majority of governmental support for R&D. Indeed, other governments around the world are waking up to the benefits of such measures. In recent years, there has been an increase in such incentives relative to direct subsidy among the majority of OECD countries. Our British system stands out among other schemes as very well designed, being permanent, relatively simple and low cost. In comparison, some other tax incentive systems around the world are only temporary, and can involve complicated incremental computation. It is a system of incentives which neatly reflects our Conservative values of prosperity and free markets and should be bolstered in years to come.

16 comments for: Dan Lambeth: Why research and development tax credits work

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