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Industrial policy failure


The UK’s £7.3 billion flagship research and development tax credit scheme is failing to stimulate the additional spending required to meet the Government’s R&D target, concludes a new report from the Centre for Business Research at Cambridge Judge Business School.

A diverse team of electronics development engineers standing around a desk late at night, solving a project problem.
David Connell.
David Connell

The UK government’s flagship £7.3 billion-a-year tax credit scheme for research and development is failing to deliver significant additional business R&D spending as claimed by the Treasury, says a new report from the Centre for Business Research at the University of Cambridge Judge Business School. The report calls instead for new policies to address a more fundamental problem: the need to grow and retain promising science and technology companies that are now too often acquired by foreign multinationals.

“The paper makes a powerful case for looking again at R&D tax credits,” says former business secretary Greg Clark MP, Chairman of the Select Committee for Science and Technology, in a foreword to the report.

The R&D tax credit scheme has grown steadily since its introduction in 2000, now benefiting 60,000 companies a year, and its cost is equivalent to a quarter of all business R&D spending in the UK. Yet official Office of National Statistics R&D data show that the impact of the tax credits on business investment in R&D has been insignificant, concludes the report.

“The theory behind R&D tax credits, namely that a reduction in the cost of R&D will lead to an additional increase in a company’s R&D expenditure, is flawed,” says the Executive Summary of the 60-page report entitled Is the UK’s Flagship Industrial Policy a Costly Failure?, which is authored by David Connell, Senior Research Associate at the Centre for Business Research at Cambridge Judge.

The report challenges government claims that each £1 of R&D tax credits generates between £1.40 and £1.70 of additional R&D spending above the credit provided.

“Since the scheme’s introduction in 2000, as a percentage of GDP, the amount companies themselves pay for R&D has fallen by at least a tenth”, says Connell.

“The Treasury’s R&D tax credit scheme has, by accident or oversight, become the Government’s flagship industrial policy. But without the scheme stimulating significant additional business spending, it cannot bridge the huge gap between current levels of business R&D expenditure and the level required to deliver on the Government’s overall target of 2.4% of national income being invested in R&D by 2027.”

The UK’s most recent estimate put R&D spending at 1.71% of GDP in 2018, up only marginally from 1.59% in 2008.

The report also argues that the UK Treasury’s £1.1 billion-a-year Patent Box scheme, introduced in 2013 to encourage companies to invest in commercialising intellectual property in the UK by charging a lower 10% rate of corporation tax, has also failed to deliver its objectives – with 92% of benefits going to large companies, and resulting in annual subsidies worth up to £50,000 for each of the employees of profitable subsidiaries of some foreign multinationals.

The report attributes the UK’s failure to grow and retain enough significant new science and tech companies to replace sectors in decline to two factors. First, the relatively small size of the UK market means that new British companies tend to grow early revenues more slowly than similar firms in larger markets like the US and China, reducing their long-term competitiveness and ability to remain independent; and second, the attractiveness of the UK as a place to make acquisitions means that early trade sales, the main exit route sought by venture capital investors, are usually to foreign multinationals, with further UK growth often curtailed.

“If we are to grow more companies like Arm and Dyson, we need to find ways of giving more entrepreneurs the opportunity to retain control over their businesses long term,” argues Connell.

The report calls for the abolition of the Patent Box scheme and a reduction and refocusing of R&D tax credits to give greater impact. It proposes that the resulting savings be reinvested in new policies more closely aligned with growing and retaining UK-based companies, including a new class of professionally managed investment funds.

In his foreword to the report, Greg Clark says: “The paper makes a powerful case for looking again at R&D tax credits and the Patent Box – subsidies paid for through the tax system which cost over £8 billion a year: 16 times more than the match-funded grants available to businesses through Innovate UK. And around half a billion pounds is thought to be subsidising research conducted outside the UK. “The government’s drive towards an innovation-intensive economy as the prime objective of national policy represents a striking ambition and now is the moment to consider if we have the policies to achieve it. If more taxpayers’ money is going to be spent on what has been established as a national imperative, we need to know it can be expected to work – or else use it more productively to accomplish the desired ends.”