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“The Impact of State Level Research and Development Tax Credits on the Quality and Quantity of Entrepreneurship” Study

The R&D tax credit is an indisputable force in the global tax arena. But it also plays a pivotal role in grassroots entrepreneurship. As it stands, 36 states offer R&D tax credits. Not bad, considering the critical role it will play in bolstering economic recovery from the COVID-19 pandemic.  The study “The Impact of State-Level Research and Development Tax Credits on the Quality and Quantity of Entrepreneurship” examines the credit through a local lens, and how it encourages entrepreneurial growth. Written by Catherine Fazio, Scott Stern and Jorge Guzman, the study was conducted at Massachusetts Institute of Technology, an epicenter of innovation and research in the academic community.  

The study is the first of its kind to look at the effect of state R&D tax credits on new firms. To conduct this pioneering work, the researchers created their own database, the Startup Cartography project, to analyze startup quality and business over a nearly 30-year period. They also used information from the Upjohn Panel Data on Incentives and Taxes to gain insight into state tax policies. Their findings? Areas that introduce R&D tax credits see a 20-percent rise in high-quality, new-firm formation over a ten-year period. The real take-off happens at the three-year mark, with around two-percent growth in high-quality firm formation from that point through year 14.  

The study also compares state-level R&D tax credits to state-level investment tax credits. While both aim to encourage experimentation and innovation, the overlap ends there. R&D tax credits prove more beneficial to start-ups and enhance the entrepreneurial eco-system.  State-level investment tax, on the other hand, helps established companies—companies that are less likely to see substantial growth over time.  This creates a challenge for new firms trying to break into the entrepreneurial arena, as they are overpowered by big(ger) business. And the statistics don’t lie. The study finds that areas that utilize investment tax see a 12-percent drop in high-quality firm growth over the same ten-year period. What happens when states offer both the investment tax credit and the R&D tax credit? Surprisingly, it does more harm than good. The credits end up working against each other instead of in conjunction with each other.  

“States offering both R&D and investment tax credits in an effort to stimulate high-growth entrepreneurship may be offering incentives that work at cross purposes.”

While ten years seems like a considerable amount of time to see payoff, the authors have a bigger priority. Fazio, Stern, and Guzman have learned that state-level R&D tax credit ecosystems need to be more attractive to startups. They hope that their findings demonstrate that to policymakers, as well.