Testing for the Ratchet Effect in the R&D Tax Credit

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Many countries have implemented the R&D tax credit to encourage firms’ R&D spending. The design of the tax credit is important for its effectiveness. Some countries such as Korea, Taiwan, Japan, France and the US have employed an incremental R&D tax credit system. The US case that made a major change in its design from the moving average base to the fixed base in calculating the credit provides us with a natural experiment to measure the effectiveness of the tax credit from the perspective of the ratchet effect. By applying an endogenous switching regression model to US manufacturing firm data, we attempt to measure the ratchet effect of R&D credit on firms’ R&D investment. According to the empirical results, the R&D tax credit policy has been effective with the price elasticity, –1.818, for the qualified firms, and the re-design of R&D credit improved the positive impact of R&D credit. This provides some policy implication for those countries that adopted an incremental credit system. In addition, our result suggests the existence of selectivity bias in the previous literature.

Original languageEnglish
Pages (from-to)327-342
Number of pages16
JournalInternational Economic Journal
Issue number2
Publication statusPublished - 2015 Apr 3

Bibliographical note

Publisher Copyright:
© 2014 Korea International Economic Association.

All Science Journal Classification (ASJC) codes

  • General Economics,Econometrics and Finance


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