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The U.S. Congress recently made permanent the Research and Development Tax Credit and expanded it for small and medium-sized businesses. Judging by the experience of the United Kingdom, which enacted a similar policy in 2008 for businesses with less than £86 million in assets, policymakers in the United States can now expect to see a significant increase in innovation.
Scholars from the London School of Economics recently examined business R&D data covering more than two million U.K. companies between 2009 and 2011. Their findings show that with the tax credit, private R&D roughly doubled, and patenting output increased by about 60 percent. They went on to estimate that every £1 worth of credit stimulated £1.70 worth of R&D activity.
The scholars based their estimates on trends they identified in the relationships between firm asset sizes, R&D expenditures, and patent outputs. They discovered that the statistical relationships between these variables were different for firms with less than £86 million in assets than they were for firms with more than £86 million in assets—and these differences can be explained by the fact that the smaller firms were able to take advantage of the R&D credit while the larger firms were not.
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