Fiscal Studies (1996) vol. 16, no. 2, pp. 21-44 © Institute for Fiscal Studies, 1999 Tax Incentives for R&D RACHEL GRIFFITH, DANIEL SANDLER and JOHN VAN REENEN 1 I. INTRODUCTION A long-standing concern surrounding the performance of the UK economy is its perceived failure to maintain the same technological pace as its competitors. Industrial research and development (R&D) expenditure 2 as a proportion of GDP fell during the 1980s at a time when all other G7 countries increased the proportion of their output given over to R&D. This ratio is now lower in the UK than in most other G7 countries. If this world-wide trend toward more R&D indicates that industrial production is becoming increasingly science-based, then the UK may be in danger of becoming a relatively low-tech economy. One purpose of this article is to examine whether there is a rational basis for these fears. The explicit policy of the UK government has been to move away from the direct funding of R&D. The recent White Paper on Science and Technology 3 emphasised diffusion and technology transfer as the key policy initiative. 1 Rachel Griffith is a Senior Research Officer at the Institute for Fiscal Studies; Daniel Sandler is a Research Fellow of the Institute for Fiscal Studies and of the Chartered Institute of Taxation, and in the Faculty of Law, University of Cambridge; John Van Reenen is a Project Manager at the Institute for Fiscal Studies and a Lecturer at University College London. The authors would like to thank Richard Blundell, Michael Devereux, Naercio Menezes Filho, Annette Ryan and participants in the OECD conference on fiscal incentives for R&D and the 1994 Industrial Economists Study Group meeting at the London Business School. This work is part of a programme of research at the ESRC Centre for the Microeconomic Analysis of Fiscal Policy at the Institute for Fiscal Studies. 2 This refers to business expenditure on research and development (BERD) performed in the UK (by UK firms and others). It includes government-funded R&D performed by the corporate sector, but not publicly performed R&D (in universities or by the Ministry of Defence, for example). 3 ‘The Government does not consider there to be a case for general tax incentives for spending on R&D’ (HMSO, 1993, p. 13).