Back-of-Envelope Math on R&D

To flesh out the cost-effectiveness issue outlined below, consider the following figures.

McKenzie estimates that a 10% decrease in the cost of R&D due to a tax credit increases R&D by 2% in the short term and 7% in the long term, but that a 10% decrease in the effective tax rate on production increases R&D by 3% in the short term and 9% in the long term. At first glance, it seems that a general tax reduction would be more effective than a tax credit.

However, in 2003, Canada conducted $22.5 billion of R&D and Canadian governments collected $363.0 billion of taxes. Therefore, reducing the cost of all R&D by 10% would cost $2.3 billion per year, or $2.4 billion after the consequent long-term increase. Reducing overall taxes by 10% would cost $36.3 billion per year. Perhaps, by concentrating on reducing taxes that are most burdensome to business, this figure could be lowered to $12.1 billion.

Put another way, $1 billion of incentives would lower the cost of R&D by 4%, increasing R&D by an estimated 3% in the long term. However, $1 billion of business-tax cuts would reduce the effective tax rate by 0.8% at most, increasing R&D by an estimated 0.7% in the long term. Even if one accepts McKenzie’s estimates and assumes that business taxes can be cut cheaply, a dollar put into tax credits would have four times the effect on R&D as one put into tax cuts.