Tax policy endogeneity: evidence from R&D tax credits

This paper estimates the causal effect of research and development (R&D) tax incentives on R&D expenditures using new data on U.S. states. Identifying tax variation comes from changes in federal corporate tax laws that heterogeneously and, due to the simultaneity of state and federal corporate taxes, automatically affect state-level tax laws. Instrumental variables regressions indicate that a 1% increase in R&D tax incentives causes a statistically significant 2.8–3.8% increase in R&D. Alternatively, ordinary least squares (OLS) regressions of R&D expenditures on R&D tax incentives, which do not correct for the policy endogeneity of R&D tax incentives, indicate that a 1% increase in R&D tax incentives causes a statistically insignificant 0.4–0.7% increase in R&D. One possible explanation for these results is that tax policies are implemented before an economic downturn.