A BERD in the hand

| May 19, 2011

On 5 May 2011 The Australian Business Foundation released The BERD in the hand: Supporting Business Investment in Research and Development which I authored.

Both Narelle Kennedy of the Australian Business Foundation and myself were members of the Cutler Review which proposed changing the existing R&D tax concession. The paper argues that the government’s proposed scheme is a big improvement on the status quo. It is likely to boost R&D undertaken by small businesses and it gives Australia more value for money from its R&D spend.

You can download the full report from the Australian Business Foundation here.

The following opinion piece was first published in The Australian Financial Review.

Often the politics of compromise works well as different interest groups get their needs taken into account and problems get solved.  But sometimes it takes us further from where we should be because we get caught up in pacifying those who have acquired entitlements under some previous arrangements and we lose sight of the ultimate destination.  As parliament debates proposed changes to the R&D tax benefit it must choose between making a good scheme work even better and outlaying more revenue to buying off some disaffected businesses with negligible return.

As I concluded in a recent study into Business Expenditure on Research and Development (BERD) for the Australian Business Foundation, The BERD in the hand: Supporting Business Investment in Research and Development, if forced to choose, I’d abolish the current tax concession for R&D rather than maintain it.  Why? When it was introduced in the mid 1980s the tax concession provided 24.5 cents in assistance for every dollar spent on R&D. Today, with large reductions in the company tax rate and even larger reductions in the nominal rate of assistance – from 150 to 125 per cent – the rate of assistance has fallen to just 7.5 per cent.

That means it has very little effect on business decision making – that in over nine tenths of cases the concession is enjoyed as a windfall on R&D that would have been done anyway. So the existing scheme probably generates more administrative, compliance and revenue costs than it does R&D benefits.

At the same time the current scheme is complex with multiple sub-schemes. Further, though the rate of assistance is low, some businesses have been able to claim a large share of their total production activities as R&D related. This sounds fair enough, but if there are limits to how much can be spent assisting R&D, every dollar spent assisting production is a dollar that can’t be spent assisting the core of an R&D project. Thus both Canada and the UK provide much more generous R&D incentives, but rule out all production activities.

Fortunately there’s a better option than abolishing the scheme – improving the current scheme – which the Cutler Review recommended.  The changes the government is proposing ramp up the rate of assistance to R&D – from 7.5 to 10 and 15 per cent for large and small firms respectively and this is made broadly revenue neutral by abolishing several sub-schemes within the existing concession and by focusing the assistance more tightly on R&D activity and ruling out production activity unless undertaken for the “dominant purpose” of supporting R&D.

I explored the issue with an open mind, but ended up impressed with the way the Treasury proposed dealing with the problem of excessive claims on production.  The new scheme distinguishes production undertaken with the dominant purpose of supporting R&D (which remains eligible) from other production which is ineligible even if it has some direct relation with R&D (which becomes ineligible).  

Because the more stringent tests on production has a negative effect on some businesses, political debate and possible compromise has focused on softening this feature of the new arrangements for instance by capping claims on production or allowing incidental production for small firms but not large ones. But if those seeking amendments really want to maximise their policy impact on R&D they won’t choose this option. Pretty obviously, production that isn’t being done for the dominant purpose of supporting R&D would take place for its own (production based) reasons, with or without assistance.

But we do know one way policy can help increase R&D.  When it was first introduced the tax concession operated solely to reduce the amount of tax payable – which meant that if you were in tax loss, as many R&D intensive firms are – you had to wait sometimes years before the concession was any help to you.  In 2001, though the rate of assistance remained measly, smaller firms in tax loss were given access to their concession as a cash grant.

Their R&D responded strongly showing that cash flow constraints were constraining their otherwise healthy desire to do more R&D. So if we want to make a difference getting small firms their money sooner could have a substantial impact. And it would be relatively cheap for government because it has a very low cost of capital.

But whatever we do, we should avoid further delay. Small businesses are likely to put any R&D on hold until our hung parliament decides what it will do.

This opinion piece was first published in The Australian Financial Review.

We invite you to think, consider and add your voice to the new ideas on business research and development canvassed here.

 

Nicholas Gruen is CEO of Lateral Economics and was a member of the Panel reviewing Australia’s Innovation System in 2008 chaired by Terry Cutler. The Australian Business Foundation is a business-sponsored collaborative research body that partners with expert researchers and practitioners. It develops its research to see further, delve deeper and make connections others don’t, backed by a vibrant community of business, government and community leaders. 

 

 

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