Tax incentives, adjustment costs, and R&D investment in China

Tax incentives for firms’ research and development (R&D) activities have been widely used to solve the “market failure” problem and to increase firms’ R&D investment. However, there is no consensus on whether the incentive effects of R&D tax policies are effective. This study empirically analyses the moderating effect of the adjustment costs of R&D on the incentive effects of R&D tax policies in China. The results show that tax incentives policies stimulate firms’ R&D investment. However, the incentive effect of tax incentives weakens as adjustment costs increase. When the adjustment cost is greater than a critical value (0.012), the tax incentive effect of R&D disappears. About 93% of Chinese firms have adjustment costs lower than this critical value, which suggests that China’s R&D tax incentives policy is generally effective. This study also finds that the incentive effect of tax policy on R&D investment is more significant for non-state-owned firms than for state-owned firms.