Time to expand R&D credit for large Korean firms

By Robert D. Atkinson

Technological innovation is the foundation of economic progress, and research and development is the rocket fuel of innovation. That's why governments around the world provide financial support for R&D, both directly through grants and indirectly through tax incentives for companies, big and small.

The logic for subsidizing corporate R&D is straightforward: the private rates of return from R&D are much smaller than the public ones. One study found that the median private rate of return from 20 prominent innovations was 27 percent. The median social rate of return, however, was 99 percent, implying substantial spillover effects.

The Obama administration estimated that the social value created by one dollar of tax credit was between two and three dollars. Other studies have confirmed that the total returns to research are significantly larger than the private returns earned by the companies that pay for it.

As a result, as one study showed, companies conduct significantly less research than is socially optimal. The R&D tax credit partially addresses this imbalance between private and social benefits by lowering the after-tax cost of research for firms.

However, as of 2020, among the 30 OECD nations with more than 4 million people, plus the BRIC nations (Brazil, Russia, India and China), Korea's R&D tax credit support for large taxable firms ranks just 30th in its generosity.

Its R&D tax credit is just 45 percent as generous as the U.S. credit, 27 percent of the median credit in these 34 nations, and just 16 percent of the credit large firms in China can receive. In other words, large firms in Korea are at a disadvantage relative to most large firms around the world when it comes to investing in R&D.

The OECD reports that the implied R&D tax subsidy rate for large firms is just 12 percent of the OECD median. This is why large firms in Korea receive just 42 percent of total R&D tax credit support (with small firms getting 58 percent), large firms in the United States receive 91 percent of R&D tax credit support.

This situation is not because there are more large firms in the United States doing R&D; it's because Korea is almost unique in having a severe two-tier R&D credit system with much higher incentives for small firms than for large firms. Large firms not only receive a lower credit rate, they face a ceiling on how much R&D can qualify for the credit.

This limitation makes little or no sense if the goal is to maximize innovation and R&D. As I point out in "Big Is Beautiful: Debunking the Myth of Small Business," the average R&D spending per worker increases with company size, with firms with five to 99 workers spending around $790 per worker and large firms with 5,000 or more workers spending around $3,370 per worker.

Likewise, innovation scholar Luc Soete found that "inventive activity seems to increase more than proportionately with firm size." According to him, minimizing support for large firms' R&D would mean reducing innovation in Korea.

Given the intense race for global innovation advantage, Korea cannot afford to have such a lopsided R&D tax credit support system. Korea's large technology firms, even more than small ones, are in a battle for global market share, including with firms whose governments provide them with much more generous R&D credits.

There is another reason for why the Korean government should boost its R&D incentives for large firms: it will spur growth. Virtually all scholarly research around the world has found the R&D tax incentives spur more R&D than they cost, and that this R&D spurs additional economic growth.

Based on these models, the Information Technology and Innovation Foundation found that increasing the U.S. R&D credit rate by 6 percentage points would boost U.S. GDP growth by $66 billion more a year.

Moreover, the tax revenues from that increased growth would exceed tax expenditure costs after 15 years. In other words, the credit would pay for itself and more. There is no reason to suspect that this would be any different in Korea, especially if increases in large firm incentives were to the incremental tax credit, rather than the flat volume credit.

While Korea should do more to equalize the imbalance in how large and small firms are treated for R&D tax credit purposes, there is one step Korea should take with respect to small firms, in this case startups, and that is to make the credit refundable.

This is particularly important for young firms with limited cash flow. In the United States, pre-profit startups can use the credit to offset the payroll taxes they pay to the federal government. This measure can be a useful tool to help innovative startups in Korea with limited cash flow.

The race for global innovation advantage is never over. Korea has performed extremely well in that race over the last two decades. But if it wants to stay near the head of the pack, it needs to keep working at it. Fixing the R&D credit system for large firms is a key way to do that.

Robert D. Atkinson (@RobAtkinsonITIF) is the president of the Information Technology and Innovation Foundation (ITIF), an independent, nonpartisan research and educational institute focusing on the intersection of technological innovation and public policy.