How effective are level-based R&D tax credits? Evidence from the Netherlands

This article examines the impact of the R&D fiscal incentive programme on R&D by Dutch firms. Taking a factor demand approach, we measure the elasticity of firm R&D capital accumulation to its user cost. Econometric models are estimated using a rich unbalanced panel of firm data covering the period 1996 to 2004 with firm specific R&D user costs varying with tax incentives. Using the estimated user cost elasticity, we perform a cost-benefit analysis of the R&D incentive programme. We find some evidence of additionality suggesting that the level based programme of R&D incentives in the Netherlands is effective in stimulating firms' investment in R&D. However, the hypothesis of crowding out can be rejected only for small firms. The analysis also indicates that the level based nature of the fiscal incentive scheme leads to a substantial social deadweight loss.