2 Lampiran A - Perbedaan SAK ETAP Vs IFRS For SMEs (2015) - Final

Journal of Contemporary Accounting & Economics 13 (2017) 52–68
Contents lists available at ScienceDirect
Journal of Contemporary
Accounting & Economics
journal homepage: www.elsevier.com/locate/jcae
The incentive effects of R&D tax credits: An empirical

examination in an emerging economy q
Ming-Chin Chen a,1, Sanjay Gupta b,⇑
a
Department of Accounting, College of Commerce, National Chengchi University, Taiwan
b
Department of Accounting & Information Systems, Eli Broad College of Business, Michigan State University, United States
a r t i c l e i n f o a b s t r a c t
Article history: This paper investigates whether an increase in the R&D tax credit rate stimulates firms’
Received 15 February 2016 incremental R&D spending. We find that the increase in the credit rate has a positive effect
Accepted 1 November 2016 on the R&D spending of high-tech firms with taxable status, but does not have the same
Available online 8 February 2017
positive effect on non-high tech firms. These results indicate that tax incentives alone
may not be effective to increase R&D spending if firms do not have profitable innovation
JEL classification: opportunities. Further, we find that when the tax incentive is structured as a credit based
H25
on incremental R&D spending over a moving-average base, firms opportunistically time
H32
O31
their R&D spending patterns to obtain additional tax credits, resulting in greater variability
O38 in R&D spending and potentially the unintended loss of tax revenues. This study con-
tributes to the ongoing global debate about the efficacy of tax policies toward R&D by pro-
Keywords: viding firm-level evidence from a large cross-section of firms in an emerging economy.
Research and development expenditure Ó 2017 Elsevier Ltd. All rights reserved.
R&D tax credits
Tax incentives
Emerging economy
1. Introduction
This study examines the impact of Taiwan’s tax policy toward research and development (R&D) on the magnitude and
pattern of firms’ R&D spending. We first examine the effectiveness of raising the rate of R&D credit in stimulating additional
R&D spending. Second, we examine the effect of a change in the credit’s structure on firms’ R&D spending patterns, and
whether the patterns reflect opportunistic timing of R&D expenses.
R&D is vital for both firms’ technological advancements and the competitive edge of a nation’s economy. Prior research
has also documented the importance of R&D in enhancing firms’ productivity and profitability (Sougiannis, 1994; Green
et al., 1996).2 Therefore, stimulating private investment in R&D has always been an important public policy goal. Achieving this
goal is especially critical for developing countries that seek to foster economic growth and gain competitive advantages in global
q
We appreciate the useful comments and suggestions of participants at the JCAE Symposium in Monash University in Malaysia, especially Discussant
Grant Richardson. We are grateful for comments received from the JCAE reviewer and editor.
⇑ Corresponding author.
E-mail addresses: mingchin@nccu.edu.tw (M.-C. Chen), gupta@bus.msu.edu (S. Gupta).
1
The author is grateful to the Ministry of Science and Technology (MOST 102-2410-H-004-030-MY2) (Taiwan) for providing funding for this study.
2
Using 573 U.S. firms from 1975–1985, Sougiannis (1994) found that an additional dollar of R&D spending increases earnings by about $2 in the following
seven years, and increases firm market value by about $5. Using a sample of 662 U.K. companies from 1990–1992, Green et al. (1996) found that the U.K. stock
market places a higher value on firms with greater R&D intensity.
http://dx.doi.org/10.1016/j.jcae.2017.01.001
1815-5669/Ó 2017 Elsevier Ltd. All rights reserved.
M.-C. Chen, S. Gupta / Journal of Contemporary Accounting & Economics 13 (2017) 52–68 53
markets. Taiwan’s government has provided substantial tax credits for firms’ R&D spending since 1991. In 2002, the effective
R&D credit rate was raised from 25% to 30%, exceeding the then business income tax rate of 25% in Taiwan.3
Despite unanimity in recognizing the importance of R&D, considerable concern has been raised in Taiwan about the effec-
tiveness of the tax subsidy in stimulating firms’ investments in R&D and on aggregate tax collections. For example, Taiwan’s
most-widely circulating business newspapers, The Commercial Times and The Economic Daily News, have criticized the R&D
tax credits as ‘‘over-abundant” and questioned the effectiveness of the nation’s R&D investment policy.4 Taiwan’s Ministry
of Finance also cautioned about the growing loss of revenues from tax incentives and the then-Minister of Finance Lin Chun
urged that tax incentives granted to stimulate the economy should be evaluated using empirical evidence to determine their
effectiveness.5 These revenue/effectiveness concerns and exhortations for evidence-based design of tax incentives are similar
to the long-standing debate in the U.S. regarding its R&D tax policy. Hence, our first objective of this study is to empirically
examine the impact of increasing the R&D tax credit rate on firms’ R&D spending in Taiwan.
In addition to the base credit for firms’ total R&D spending, since the year 2000 Taiwan has also offered a liberal tax incen-
tive for incremental R&D spending. Under the incremental credit, the R&D credit rate is increased to 50% for the excess of a
firm’s current-year R&D spending over the average of its previous two years’ R&D expenditures. Whereas Taiwan’s base
credit is similar to Canada’s straight credit regime, the incremental portion of Taiwan’s credit resembles the U.S. regime
which allows an R&D tax credit only on incremental R&D expenditures.6 Thus, Taiwan’s R&D credit is structured as a combi-
nation of the strict incremental credit in the U.S. and the straight credit in Canada, offering a unique setting to examine firms’
responses to R&D tax policy. In particular, this credit structure provides firms a strong incentive to manage the timing of their
R&D spending. For example, each dollar of R&D expense deferred to the next year increases next year’s credit base by $0.50 and
the tax credit by $0.25, even though the total spending over the two-year period is unchanged. Firms can similarly increase their
credit by accelerating their expenses to an earlier year or by both accelerating and deferring expenses to different time periods.
Hence, the second objective of this study is to examine whether firms’ R&D spending patterns reflect opportunistic timing to
take advantage of the 50% credit rate for incremental R&D spending. We also examine the resulting impact of such spending
patterns on aggregate tax collections.
Using firm-level data from a large sample of non-financial Taiwanese firms, we estimate year and firm fixed effects
regression models of R&D intensity (R&D expenses scaled by sales) as a function of tax incentives along with several controls
for nontax factors. We find that the increase in the credit rate has a positive effect on the R&D spending of high-tech firms
with a taxable status that allows them to claim the benefit of tax credits, but does not have the same positive effect on non-
high tech firms. In magnitude terms, the increased R&D spending for high-tech (non-high tech) firms is about 27.57% (6.45%),
or 16.84% for the overall sample. These magnitude estimates translate into a credit-induced increase in R&D spending in Tai-
wan of $3.91 per dollar of revenue forgone. The comparative cost-effectiveness amounts are lower in the U.S. data (e.g., $1.74
in Berger, 1993; $2.96 in Klassen et al., 2004; $3.54 for high-tech firms and $1.68 for non-high tech firms in Gupta et al.,
2011) and in Canadian data (e.g., $0.33 in Mansfield, 1986; $1.30 in Klassen et al., 2004). The higher credit-induced additional
R&D spending for our sample is likely due to Taiwan’s large high-tech sector that has more growth and innovation
opportunities.
To examine whether firms opportunistically time their R&D spending in response to the 50% incremental credit enacted
in 2000, we conduct three related tests and find that (1) the variations in R&D spending increased significantly from the per-
iod 1996–1999 to 2000–2003, (2) the forecast errors of R&D spending increased significantly from the period 1996–1999 to
2000–2003, and (3) the percentage of incremental credit-qualified firms based on realized R&D spending was significantly
greater than that percentage based on forecast spending in 2000–2003. Together, this evidence is consistent with firms
opportunistically timing their R&D spending to take advantage of the incremental credit. Using the forecast credit amount
based forecast R&D spending as a benchmark, we estimate the tax revenue loss from firms’ strategically timing R&D spend-
ing at about NT $32,207 million (or about 2.35% of actual corporate tax collections) during 2000–2003.
Our study makes several contributions to the literature. First it contributes to the R&D tax policy debate in important
ways. Hall and Van Reenan’s (2000) survey of the extant literature shows that most prior studies are based on U.S. and
Canadian data, and that evidence on the effectiveness of R&D tax subsidies in emerging economies is virtually non-
3
The Statute for Upgrading Industries (Taiwan) (1991–2009) establishes substantial tax incentives for various firms’ investments, including the R&D tax
credit. The effective R&D credit rate was 15% in 1991, and was raised to 20% in 1993, 25% in 2000, and 30% in 2002. Because of the enormous loss of tax revenue,
the Taiwanese government repealed the Statute for Upgrading Industries in 2010. As part of the tax reform, the corporate tax rate was reduced to 17% from 25%
in 2010. We did not examine the effect of changes in credit rates in the period 1991–1999 because the then financial accounting standards (Taiwan) did not
require firms to separately disclose R&D expenses before 2000. However, some firms did voluntarily disclose their R&D expenses which we use in our variance
tests below.
4
The Commercial Times (2004.10.28, 08 and 2005.3.13, 09) reported that claimed R&D tax credits by companies were about 40 billion NT dollars annually and
criticized that Taiwan’s abundant tax credits for R&D expenditures were probably the highest in the world. The Economic Daily News (2002.9.27, 02) cast doubts
on the advancement of the technologies brought about by R&D expenditures and reported that the R&D intensity (R&D expenditures sales) in the private
sector decreased from 1.39% in 1998 to 1.28% in 2000.
5
The Tax Journal Editorial, 2002.12.20., Realities and Compromises on the Tax Reform, The Tax Journal 1844: 6 (in Chinese).
6
In Canada, all qualified SR&ED (scientific research and experimental development) expenditures are eligible for a 20% investment tax credit (Klassen et al.,
2004). In the U.S., the R&D tax credit is generally available on the incremental R&D expenses over a fixed base percentage times the average gross receipts over
the previous four years, with the fixed base percentage calculated as the ratio of the firm’s R&D expenses to gross receipts during 1984–88 (Gupta et al., 2011).
54 M.-C. Chen, S. Gupta / Journal of Contemporary Accounting & Economics 13 (2017) 52–68
existent. Our study aims to fill this gap by providing to our knowledge first-time firm-level evidence from Taiwan, widely
considered an important emerging economy.7 We believe that R&D in developed and developing countries may represent dif-
ferent segmentations in the R&D value chain. Specifically, R&D in developed countries tends to focus more on new product
development, whereas R&D in developing countries tends to focus on manufacturing and process innovation. This market seg-
mentation appears to be reflected in the tax policies for R&D incentives pursued in these economies. For instance, in the U.S.
only ‘‘research and experimentation” qualifies for the tax credit, whereas in Taiwan both research and development qualify
for the tax credit.8 The broader base of activities eligible for R&D incentives in developing countries such as Taiwan may imply
a greater elasticity of R&D expenditures to the tax incentives than in developed countries. Therefore, our findings can have
implications for countries’ selection of the base (narrow vs. broad) eligible for R&D tax incentives.
Second, as described above, the design of the Taiwanese R&D tax credit has interesting features combining a straight
credit with an incremental credit based on a moving average of R&D spending. The latter aspect of the credit design bears
some similarities to the changes that were made to the tax credit in the U.S. under the Omnibus Budget Reconciliation Act of
1989. Our study has the potential to contribute to our understanding of how the design of the tax credit affects firms’ R&D
spending and reporting incentives.9
Third, from an empirical standpoint, our study overcomes two important data limitations of the prior studies that
stemmed from using publicly-available data from financial statements – lack of book-tax conformity in the definition of
R&D expenses and missing data on R&D spending. In its review of the literature, the U.S. Government Accountability Office
(GAO, 1996) concluded that these problems may have led to the mixed evidence on R&D tax incentives found in prior stud-
ies. In the U.S. there is a significant disconformity between the R&D expenses reported in financial statements and the R&D
expenditures that qualify for the tax credit. In contrast, there is a high degree of book-tax conformity in the R&D expenses
reported by Taiwanese firms, which we confirmed through limited access to confidential tax return data. Further, just as in
the U.S., Taiwanese firms also have R&D data missing in financial statements. We surveyed our sample firms to obtain the
missing data. Thus our study significantly mitigates both the non-conformity and missing data problems and provides for
cleaner tests and inferences.
Fourth, controlling for industry membership is critical in models of R&D spending since inter-industry differences in mar-
ket structure, demand conditions, technological opportunity, and appropriability that are unobservable or hard to measure
can confound inferences about variables of interest. Yet, adequately implementing this control beyond broad industry mem-
bership measures, such as firms’ primary industry code assuming them to be single-product entities (e.g., Cohen et al., 1987),
has been difficult. A significant advantage of the Taiwanese data is the dominance of the electronics industry, which tends to
be homogeneous along several dimensions and comprises nearly half the sample firms. Given their characteristics, we cat-
egorize firms in this industry as high-tech firms which allows for a clearer analysis of the interaction between innovation and
technological opportunities with tax incentives and the resulting impact on firms’ R&D spending.
The remainder of this paper proceeds as follows. The next section presents the related empirical research on R&D tax
credit, followed by hypothesis development, research methods and results. The last section concludes with the implications
of our study.
2. Related literature
Although it is straightforward to predict that an R&D tax credit should result in increased R&D spending since the credit
lowers the marginal costs of R&D investments, prior empirical research has yielded mixed results on the credit’s effective-
ness. Early studies generally found a negligible effect. For example, using a sample of 55 Canadian companies conducting
R&D, Mansfield and Switzer (1985a) estimated that tax incentives have increased R&D expenditures by about 3%, apparently
much less than the revenue losses to the government.10 Mansfield and Switzer (1985b) indicated that U.S. and Canadian tax
incentives increased firms’ R&D expenditures by only about 1.2% and 2%, respectively. Similarly, based on samples comprising
110 U.S., 55 Canadian, and 40 Swedish companies, Mansfield (1986) found that R&D tax incentives increased industrial R&D by
1% or 2%, which was about one-third of the foregone government revenues.
In contrast, Berger’s (1993) study of the effects of introducing an R&D tax credit in the U.S. by the Economic Recovery
Tax Act of 1981 showed that the credit had a significantly positive effect on firms being able to use the tax credit. Using a
7
The FTSE Group classifies Taiwan as an ‘‘advanced emerging market” on the basis of national income and the development of market infrastructure (see
http://ftse.com/Indices/Country_Classification/index.jsp). As of June 2006, the Morgan Stanley Emerging Market Index, which is designed to measure equity
market performance in global emerging markets, included Taiwan (see http://www.mscibarra.com/products/indices/licd/em.html).
8
Article 86 of the Income Tax Assessment Rules for Profit-Seeking Enterprises (the Taiwanese tax code) defines qualified R&D expenses broadly to include
expenses incurred for researching and developing new products or new technology, and for improving production and service technology and manufacturing
processes. The specific qualified expenses include R&D personnel salaries, R&D building and equipment depreciation, and R&D overhead.
9
In examining the 2002 increased credit rate effect, we only select the post-2000 incremental tax credit years (2000–2003) as our sample period in order to
keep the incentive effect of incremental tax credit constant in the sample period. Further, our sample period covers four years after the introduction of the 2000
incremental tax credit, and, to some extent, the effect arising from firms’ strategically timing R&D spending to maximize the incremental R&D credits is likely to
be reversed and averaged out during a period of four years.
10
The 55 companies’ R&D expenditures accounted for about 30% of Canadian firms carrying out R&D. Reasons for the modest effect of R&D tax incentives
include: lack of tax liability against which to utilize the credits, small reduction in the after-tax price of R&D, and price inelasticity of demand for R&D.
sample of 263 U.S. firms with data from 1975–1989, he found an average increase of 2.9% in their R&D spending, which
translates into about $1.74 of additional R&D spending per revenue dollar foregone by the government and suggests a
more cost-effective credit than previous studies.11 However, Berger (1993) also showed that inferences about the credit’s
spending effects are overstated by the significant implicit tax costs induced by the tax subsidy that cause prices to rise.
Hence, a portion of the observed spending increase is not due to an increase in the quantity of investment in R&D. In addi-
tion, he found that, after controlling for nontax factors, firms unable to use the credit did not appear to increase their R&D
spending after 1981.
Also using firm-level data for a panel of U.S. firms, Swenson (1992) found that the R&D credit generally has a positive
impact on R&D spending, but only for firms that are profitable and have high growth opportunities. Firms with low growth
opportunities continued decreasing their R&D spending despite the enactment of R&D credits in 1981.
Klassen et al. (2004) examined the effect of tax incentives on R&D spending in the U.S. and Canada by exploring the dif-
ference in the two countries’ R&D tax credit mechanisms and the accounting standards for reporting R&D in financial state-
ments. Based on a sample of 110 U.S. and 58 Canadian firms matched on industry and size, they found that, although the
Canadian tax credit mechanism is more generous, the U.S. tax incentive appears more cost-effective. Specifically, they found
that the U.S. system appears to induce on average $2.96 of additional R&D spending per dollar of revenue foregone relative to
$1.30 under the Canadian system.
The U.S. R&D tax credit has always been granted on firms’ incremental R&D spending. To obtain the R&D credit, firms
need to incur qualified R&D expenses above a certain base amount. The Omnibus Budget Reconciliation Act of 1989
(OBRA89) changed the base amount from a moving average base to a fixed base.12 Gupta et al. (2011) examined the impacts
of this structural change on firms’ eligibility for the credit. Using U.S. firm data from 1981–1994, they found that overall firm
eligibility declined after OBRA89, but increased for high-tech firms. Their estimates indicate that median R&D intensity (R&D
expense divided by sales) of high-tech (non-high tech) firms increased approximately 11% (5.4%) from 1986–1989 to 1990–
1994, producing credit-induced additional R&D spending of $3.54 ($1.68), respectively, per revenue dollar foregone, or on aver-
age $2.40 for the full-sample.
The research discussed above has not only yielded mixed results on the effectiveness of R&D tax incentives, but also is
limited to the experience of developed countries such as the U.S. and Canada. Some studies analyzed the success of economic
growth among emerging Asian countries and attributed the governments’ R&D policies as one of the main drivers of
advancements in technologies and industrialization, resulting in their dominant roles in global manufacturing supply chains
(Mathews, 2002; Lall, 2004; Nagano, 2006). For example, Korea and Taiwan’s rapid growth in the global electronics indus-
tries during 1980–2001 coincided with the dramatic increase in both countries’ R&D expenditures during that period.13 Both
governments of Korea and Taiwan have played a central role in forming business group-centered R&D strategy and in strength-
ening public R&D infrastructure that contribute to the growth of firms’ R&D productivity (Nagano, 2006). Their success demon-
strates that governmental policies toward R&D investment are critical for developing countries seeking to sustain their
economic growth. Hence, our evidence on the effectiveness of R&D tax incentives in Taiwan can have implications for govern-
mental policies toward R&D investment in emerging economies generally.
3. Hypotheses development
Our first objective in this study is to analyze the effectiveness of the increase in Taiwan’s R&D tax credit rate from 25% to
30% in 2002 in stimulating firms’ incremental R&D spending. As discussed before, whether tax incentives are an effective tool
in increasing firms’ investment in R&D remains unsettled. However, the five percentage point increase in Taiwan’s credit rate
substantially reduced firms’ marginal costs of R&D investment and provides a powerful setting to reexamine this question.
For the R&D credit to be an effective policy tool for increasing firms’ R&D investment, two conditions are necessary: first,
firms should have sufficient tax liabilities to utilize the tax credit; and second, firms should have additional profitable inno-
vation opportunities to initiate new R&D projects. We argue that, in general, the high-tech industry has relatively more inno-
vation opportunities than non-high tech industries as reflected in their significantly higher market-to-book ratios,14 and thus
high-tech firms may have greater incentive to increase R&D spending in response to the increase in the credit rate. Therefore,
our first set of hypotheses relating to the increase in the R&D tax credit rate is as follows:
H1a. The increase in the R&D tax credit rate from 25% to 30% in the year 2002 will have a positive effect on the R&D spending
of firms with taxable status, ceteris paribus.
11
For example, Tillinger (1991) estimated that credit-induced R&D is less than 2% of credit-eligible R&D, and that the credit only produces about $0.40
additional R&D spending for each tax revenue dollar foregone.
12
Using a moving average base for incremental R&D tax credit has been heavily criticized for possibly resulting in disincentive effects (see Eisner et al., 1984;
Altshuler, 1988).
13
Korea’s R&D/GDP grew from 0.8% in 1980 to 3% in 2001; Taiwan’s R&D/GDP grew from 0.7% in 1980 to 2.2% in 2001 (Nagano, 2006, Table 2, p. 656).
14
Empirical research often uses market-to-book ratios as a proxy for firms’ growth opportunities. Higher market values relative to book values suggest that
the market perceives that such growth opportunities lie ahead. The market-to-book ratios of high-tech firms generally are higher than those of firms in non-
high tech industries.
H1b. The increase in the R&D tax credit rate from 25% to 30% in the year 2002 will have a greater positive effect on the R&D
spending of high-tech firms than non-high tech firms, ceteris paribus.
The second objective of this study is to examine whether the change in the credit’s structure to incorporate an additional
tax credit based on incremental R&D spending is associated with firms’ opportunistic timing of their R&D spending patterns
to maximize the tax credits. To encourage incremental R&D investment, since the year 2000 Taiwan has increased the tax
credit rate to 50% for the excess of firms’ current R&D spending over their previous two years’ spending average.15 The
moving-average base for the 50% credit rate, however, provides a strong incentive for firms to time their spending patterns
by either deferring or accelerating (or both deferring and accelerating) R&D expenditures from one year to another. For example,
for every dollar of R&D expenses deferred to the next year, the next year’s credit base is increased by $0.50 and the tax credit by
$0.25.
The following examples illustrate how firms can increase their tax credit by planning their R&D spending across years
even though they do not increase their aggregate R&D spending over that same time period.
Example 1 Example 2
Year R&D spending Tax credit Year R&D spending Tax credit
1999 $10 million $2.5 million 1999 $10 million $2.5 million
2000 $10 million $2.5 million 2000 $ 5 million $1.25 million
2001 $10 million $2.5 million 2001 $15 million $5.625 million*
Total $60 million $15.0 million Total $60 million $16.875 million
*
The average of 1999–2000s R&D spending is $7.5 million. Therefore, the R&D tax credit for 2001 = $7.5 million 25% + ($15 million $7.5 million)
50% = $5.625 million.
In example 1, if a firm plans to invest $10 million each year in R&D during 1999–2001 for a total of $30 million, given the
credit rate of 25%, it can receive tax credits of $2.5 million each year, i.e., $7.5 million in total during 1999–2001. Yet, in
example 2, if the firm strategically plans its R&D spending by deferring $5 million spending from 2000 to 2001, its total
tax credits during 1999–2001 will be increased by 25% to $9.375 million, even though its total R&D spending over this period
is the same $30 million as in example 1. Note that, assuming the firm maintains its R&D spending as regularly planned in the
following three years (2002–2004), it still receives the base credit of a total of $7.5 million in either example. That is, firms
may maximize their R&D credits by strategically timing their spending by either accelerating the next year’s R&D spending
to the current year or deferring some expenses to a later year, without producing potentially negative effects on its future
base credit.
The consequence of accelerating or deferring R&D spending over a period of years to obtain the 50% credit rate is to
increase the variability in firms’ annual R&D spending patterns. Assuming firms do not opportunistically plan their R&D
spending in response to the enactment of incremental credit in 2000, we would not expect any difference in the variations
in R&D spending between pre- and post-2000 periods. However, if firms take measures to plan their R&D spending by either
postponing the previous year’s R&D spending to the current year or expediting the next year’s spending to the current year
after the rate structure change in 2000, the variations in R&D spending after the year 2000 will become greater. Accordingly,
given the strong incentive provided by the incremental tax credit for firms to plan R&D spending over years, we propose the
following hypothesis:
H2. The year 2000 increase in the R&D tax credit rate to 50% for the excess of a firm’s current R&D spending over its previous
two years’ average will increase the variability in firms’ annual R&D spending, ceteris paribus.
4. Research methods
Our empirical approach to test the hypotheses is as follows. First, to examine the incentive effects of the increase in the
R&D tax credit, we estimate a regression model of R&D spending. Second, to examine firms’ timing of their R&D spending
patterns, we compare the variances of firms’ R&D spending between pre- and post-2000 periods. Lastly, to estimate the rev-
enue impact of firms’ R&D spending patterns, we use the results of the regression model to forecast each firm’s R&D spending
and then calculate the effects on aggregate tax revenue collections by comparing the actual with the forecasted values.
h i
15
The structure of the credit may be more formally defined as follows: cL R&Dt þ cI R&Dt R&Dt1 þR&D
2
t2
where cL is the base credit rate and cI is the
n h io
incremental credit rate. The effective overall credit rate in this case is cL þ cI 1 12 ð1þ1 qÞ þ 1
where q is the appropriate discount rate.
ð1þqÞ2
4.1. Regression model of R&D spending
The dependent variable in the R&D spending regression model is R&D intensity (RDI), defined as R&D expenditures
divided by net sales. Scaling R&D expenditures by sales provides a comparable basis for firms of different sizes and more
importantly controls for the inherent growing trend in R&D as sales grow.16 The explanatory variables in the model consist
of the test variables related to our research hypotheses and control variables that draw on the industrial organization literature
and prior studies in the area to account for nontax factors likely to influence firms’ R&D spending (Swenson, 1992; Berger, 1993;
Klassen et al., 2004; Gupta et al., 2011).
To provide additional control for nontax factors likely to influence firms’ R&D spending decisions, we use a year and firm
fixed effects estimation procedure with panel data that include both time and individual firm fixed effects. Panel data esti-
mation techniques allow control for various time-invariant factors associated with an individual firm’s R&D activities that
may be unobserved or difficult to measure. For example, corporate vision and strategy, market positioning, and product pric-
ing may determine a company’s R&D policy, even though they are largely unobservable in archival data. Because these fac-
tors may not change dramatically within a short period of time, the firm-fixed effects control for their influence in the
estimation. Similarly, firms’ R&D spending may also be affected by macro-economic factors, such as interest rates, techno-
logical progress, and government spending on R&D. Because these factors vary over time but generally not across firms, the
year fixed-effects control for their influences.
Based on the above discussion, our regression model is specified as follows:
RDIit ¼ b1i þ b2t þ a1 mRDIjt þ a2 lagRDIit þ a3 FUNDit þ a4 DEBTit þ a5 MV=BVit þ a6 SIZEit þ a7 MTRit þ a8 POST
MTRit þ a9 POST HITECHit þ eit ð1Þ
17
The subscript i represents the individual firm, j is the industry of firm i, and t is the sample year from 2000–2003. b1 and
b2, respectively, are the firm and year fixed-effects. The independent variables are defined as follows (with expected signs on
their estimated coefficients shown in parentheses) and explained in greater detail below.
mRDI (+) = mean R&D intensity (RDI) of all firms in the jth industry, j = 1, . . . , 1818;
LagRDI (+) = one-year lagged RDI;
FUND (+) = pre-R&D cash flow, measured as (operating cash flow + R&D expenditure + current tax expenses) net sales;
DEBT () = debt ratio, measured as long-term liabilities total assets;
MV/BV (+) = ratio of market-to-book value, measured as (market value of common stock + preferred stock + total liabil-
ities) total assets;
SIZE (?) = firm size, measured as the natural log of net sales;
MTR (+) = marginal tax rate;
POST = indicator variable set to 1 if the sample year is 2002 and later;
HITECH = indicator variable set to 1 if the firm is in the high-tech industry;
POST MTR (+) = the interaction term of POST and MTR; and
POST HITECH (+) = the interaction term of POST and HITECH.
The mean industry-level R&D intensity (mRDI) is defined as the average ratio of R&D expenditure to sales of all firms in an
industry, and is included to account for the within-industry influence of competitors on the individual firm’s R&D spending.
In addition, since R&D is generally a multi-period investment such that current R&D expenditures are heavily influenced by
previously planned outlays and projects, we include each firm’s one-year lagged R&D intensity to reduce autocorrelation in
the residuals created by nonstationarity in the time-series process (Berger, 1993). However, the drawback of including the
lagged dependent variable on the right-hand side in a fixed effects regression model is that it can result in inconsistent
parameter estimates (Wooldridge, 2002, p. 255–56). We address this issue in sensitivity tests.
FUND and DEBT are included to account for the source of financing investments in R&D. FUND, measured as pre-R&D cash
flow, is used to proxy for the availability of firms’ internal funds for R&D investment. DEBT, defined as the ratio of long-term
debt to total assets, is a proxy for firms’ financial leverage. Economists have long argued for the importance of financing R&D
investments internally because of the moral hazard problems associated with financing risky business activities, such as
innovation, with external financing (e.g., Kamien and Schwartz, 1978). In addition, firms with higher debt ratios may face
greater costs of financial distress and thus limit their discretionary spending, such as on R&D.19 Therefore, we expect R&D
spending to be positively related with FUND and negatively related with DEBT.
16
R&D/sales is the usual measure of R&D intensity in the industrial organization literature. Prior studies examining the incentive effects of R&D tax policy
(e.g., Berger, 1993; Gupta et al., 2011) have also used this measure as the dependent variable.
17
We select the sample years because the incremental tax credit started at 2000 and remained unchanged during the sample period. The introduction of the
incremental 2000 tax credit may induce firms to increase R&D spending relative to the period before 2000. Our research design allows us to control for the
potential effect resulting from the introduction of the incremental 2000 tax credit by selecting the sample years with the same tax incentive of incremental tax
credit.
18
The industry classifications are made by the Taiwan Stock Exchange. See Table 1 for the industry names.
19
See also Lev (2001, p.4) who notes that R&D investment is subject to greater informational asymmetry, causing greater costs for external funding.
MV/BV, the ratio of a firm’s market-to-book value, is usually used as a proxy for growth opportunities. It is included
because firms with greater growth opportunities may have more profitable innovation opportunities to initiate new R&D
projects. In addition, Swenson (1992) finds that the positive impact of the R&D credit exists only for firms with high growth
opportunities. SIZE, measured as the natural log of net sales, is used to control for potential scale effects on R&D spending.
However, the effect of firm size on R&D spending is uncertain because, while larger firms can afford bigger R&D budgets, they
also tend to be more mature and thus less likely to accelerate R&D investment.
MTR is our proxy of a firm’s marginal tax rate and is included as a measure of its tax status. We address the potential
endogeneity of a firm’s tax status (e.g., Graham, 1996a, 1996b; Gupta et al., 2011) by measuring MTR as the firm’s previous
year’s tax status (i.e., tax status at year t 1) that should be less influenced by the firm’s current operations. We exploit the
structure of Taiwan’s corporate tax rates and rules with respect to net operating losses (no carryback but a limited carryfor-
ward to 5 years during the sample period) to measure MTR as follows:
Tax status at year t 1

Positive taxable income Negative taxable income
Tax status at year t Positive taxable MTR depends only on tax status at Loss at year t 1 is carried forward
income year t (MTR = tax rate = 0.25) to offset taxable income at year t;
thus MTR = tax rate at year t = 0.25
Negative MTR is the present value of when MTR is the present value of when
taxable income expect to use up the loss expect to use up the loss
where taxable income is computed using the current tax expense reported in financial statements and statutory tax rates.20
Thus taxable income is not simply pretax income.
For the sake of simplicity, we only consider the present value of the current year’s tax paid on one additional dollar of
income without accounting for the potential effects of future taxes on the additional dollar of income (Graham, 1996a, 1996b).
If a firm has positive taxable income both in the previous and the current year, its MTR is equal to the current tax rate (i.e.,
0.25).21 If a firm has negative taxable income in the previous year and positive taxable income in the current year, its MTR is the
present value of realized tax benefit arising from previous loss for an additional dollar of income in the current year and, thus, is
equal to 0.25. Given that firms’ NOLs can only be carried forward (but not back) in Taiwan, if a firm has negative taxable income
in the current year, the tax benefit of loss depends on the present value of when expect to use up the loss. However, the max-
imum carryforward period was five years during our sample period. For simplicity, we set MTR equal to zero when a firm has
negative taxable income in the current year.
POST MTR and POST HITECH are our two main test variables for Hypothesis 1. Because we have included time fixed
effects in the regression model (1), POST is only included as an interaction term on MTR and HITECH. POST MTR is the
interaction term of MTR and the post-2002 sample period when the credit rate was increased from 25% to 30%, and provides
a test of Hypothesis H1a. Increasing the credit rate may have differential impacts on firms with different tax statuses. Firms
unable to use the credit may not have the incentive to increase R&D spending despite an increase in the credit rate
(Swenson, 1992; Berger, 1993). Therefore, we expect that firms with positive marginal tax rates are more likely to increase
R&D spending in response to the increase in the credit rate in 2002, and thus we expect the coefficient of the interaction to
be positive.
POST HITECH is the interaction term of firms in the high-tech industry and the post-2002 sample period when the
credit rate was increased from 25% to 30%, and provides a test of Hypothesis H1b. Increasing the credit rate is likely to have
a greater effect on firms with higher growth and innovation opportunities; high-tech firms have such opportunities and so
we expect the coefficient of the interaction to be positive.22
4.2. Sample selection and data
Panel A of Table 1 outlines the sample selection procedures for the regression Eq. (1). We begin with all non-financial
firms listed on the Taiwan Stock Exchange (TSE) and Over-the-Counter (OTC) Markets during 2000–2003. During this sample
period, only Taiwanese corporations can be listed on TSE and OTC.23 We delete nine firm-year observations which declared
20
In Taiwan, income tax accounting for financial statements is similar to the U.S. generally accepted accounting principles (GAAP), which require firms to
book deferred tax expenses for timing differences between book and taxable income. We use only the currently payable portion of the tax expense to compute
taxable income. Thus, taxable income is different from pretax (book) income with a correlation of 0.70.
21
In Taiwan, although the corporate tax rate schedule has two brackets, 15% and 25% during our sample period, corporate income is taxed at 25% for income
greater than NT$100,000 (about US$3125). Therefore, the corporate income tax rate is virtually one flat rate.
22
The Legislature formally amended the tax law to increase the R&D credit rate from 25% to 30% on March 27, 2002, and stated the increased credit rate to be
effective retrospectively on February 1, 2002. Therefore, our results are not subject to the problem of firms opportunistically deferring their 2001 R&D spending
until 2002.
23
During this period foreign firms were not permitted to be listed on TSE and OTC. Hence, we have less concern about differences in income-shifting
incentives among our sample firms.
Table 1
Sample selection and sample firms’ distribution by year and industry
membership.
Panel A: Sample selection procedures

Listed companies during 2000–2003 2716 firm-years
Less: firms declaring financial distress (9) firm-years
Less: firms IPO during 2000–2003 (350) firm-years
Less: firms with missing data on selected variables (39) firm-years
Less: firms with less than 3 years’ data (284) firm-years
Final sample 2034 firm-years
Year Firm-years Percentage of sample

Panel B: Sample distribution by year
2000 447 21.98
2001 530 26.06
2002 530 26.06
2003 527 25.90
Total 2034 100
Industry Firm-years Percentage of sample

Panel C: Sample distribution by industry
Cement 12 0.59
Foods 64 3.15
Plastics 80 3.93
Textiles 201 9.88
Electric & machinery 132 6.49
Electric appliance & cable 51 2.51
Chemicals 134 6.59
Glass & ceramics 32 1.57
Paper & pulp 28 1.38
Steel & iron 79 3.88
Rubber 31 1.52
Automobile 16 0.79
Electronics 955 46.95
Construction 52 2.56
Transportation 24 1.18
Tourism 8 0.39
Wholesale & retail 20 0.98
Others 115 5.65
Total 2034 100
financial distress, 350 firm-year observations whose companies were IPO firms in the sample period, and 39 firm-year obser-
vations for missing data on the selected variables. To ensure that each firm has enough observations spanning the year 2002, we
further delete firms with less than three years’ data during 2000–2003. Thus, our final sample for Eq. (1) consists of a total of
2034 firm-year observations from 530 firms.
Panels B and C of Table 1 break down the sample by year and industry, respectively. The sample is approximately evenly
distributed across the four years in the sample. The industry breakdown in Panel C shows that nearly half (about 47%) of the
sample is comprised of firms in the electronics industry. Taiwan’s emergence on the world economic stage has largely been
driven by its electronics industry, which continues to play a key role in the global supply chain. Apart from their obvious
importance to the Taiwanese economy, firms in Taiwan’s electronics industry also exhibit the highest R&D intensity and rate
of growth in R&D expenditures in our sample (see Panel B of Table 3 and Fig. 1). Further, the 2004 ROC (Taiwan) Statistical
Yearbook (Table 4-13-1) shows that in 2003 about 77% of all R&D employees in enterprises in Taiwan were in the electronics
industry, indicating that this industry had a higher ratio of highly skilled employees. Accordingly, we use electronics firms as
our high-tech sample in this study.24
Financial statement data were obtained from the Taiwan Economic Journal (TEJ) database, which is similar to Standard &
Poor’s Compustat database. As in the U.S. however, many Taiwanese firms also have missing data on R&D expenditures in
their financial statements. Hence, we conducted an extensive survey and directly contacted these firms to collect the missing
data.25
24
Our classification is based on the typical characteristics of a high technology industry, such as: (1) highly skilled employees, (2) a fast rate of growth, (3) a
high ratio of R&D expenditures to sales, and (4) a worldwide market for its products (Rogers and Larsen, 1984, 29). In addition, electronics firms generally are
also more homogeneous in the global industrial chains than other industries. Therefore, our findings in the high-tech sample in Taiwan should have broad
implications for the electronics firms in other countries.
25
We sent questionnaires to every firm whose R&D data were either missing or had a value of zero during our sample period. Of the 451 firm questionnaires
we mailed, we received usable responses from 46 firms by mail and two firms by email. For firms who did not reply, we further checked their financial
statements to verify that the coding in the database was correct.
Table 2
Comparison of financial statement and tax return data on R&D spending and R&D intensity.
Variable Mean Std. dev. Min. 10th 25th 50th 75th 90th Max.
RD_FS ($ in 000NT) 62,105 67,703 2902 6895 15,217 39,669 76,710 222,593 337,924
RD_TAX ($ in 000NT) 57,350 64,182 2757 5471 13,063 34,693 72,872 139,230 327,527
D_RD ($ in 000NT) 1388 2821 0.25 0.40 1.18 221 1157 4160 16,089
D_RDI (%) 0.0350 0.0979 0.0001 0.0001 0.0001 0.0062 0.0233 0.0605 0.7630
Tax return data are obtained from the Taiwan tax authorities. These data were provided only in aggregate for a partial sample of firms to maintain
confidentiality. To make appropriate comparison and avoid the influence of outliers, we restrict our sample to between the 10th and 90th percentiles of
D_RDI of the 2001 year sample. The restricted sample has 419 observations and the above results are based on the restricted sample.
Variable definitions:
RD_FS = R&D expense amount reported on financial statements;
RD_TAX = R&D expense amount reported on tax returns;
D_RD = the absolute value of the difference between RD_FS and RD_TAX (=|RD_FS RD_TAX|); and
D_RDI = the absolute value of the difference between R&D intensity measured by RD_FS and RD_TAX (=|RD_FS/Sales RD_TAX/Sales|).
Table 3
Sample firms’ profile and descriptive statistics for regression variables.
Variable Mean 1st percentile 25th percentile 50th percentile 75th percentile 99th percentile
Panel A: Profile of sample firms (N = 2034)
Total assets 14,729.49 584.07 2205.88 4482.09 10,257.21 187,009.27
Revenues 8976.05 166.48 1261.04 2807.42 7124.39 105,084.72
MV of equity 14,551.57 140.00 1026.00 2504.50 6808.00 237,405.00
R&D expenses 205.86 0.00 5.43 29.38 100.54 3139.02
Debt ratio 0.414 0.074 0.297 0.413 0.518 0.858
ROA 0.032 0.310 0.005 0.041 0.085 0.240
ROE 0.028# 1.304 0.034 0.045 0.107 0.306
Taxable status 0.722 0.000 0.000 1.000 1.000 1.000
Variable All firms (N = 2034) High-tech firms (N = 955) Non-high tech firms t-test for testing H0:
(N = 1079) ltech = lnontech
Mean Std. dev. Mean Std. dev. Mean Std. dev. t stat. p-value
Panel B: Descriptive statistics of regression variables
R&D expense (NT$ million) 205.86 748.59 368.40 1048.19 61.99 200.98 8.89 0.0001
Net sales (NT$ million) 8976.05 21,766.02 11,496.95 27,753.80 6744.86 14,183.79 4.77 0.0001
RDI 0.024 0.036 0.039 0.045 0.011 0.0163 18.04 0.0001
LagRDI 0.024 0.036 0.038 0.045 0.011 0.017 17.24 0.0001
mRDI 0.03 0.020 0.048 0.002 0.015 0.017 64.53 0.0001
FUND 0.125 0.164 0.141 0.177 0.111 0.151 4.15 0.0001
Debt 0.096 0.102 0.097 0.102 0.095 0.103 0.37 0.7121
MV/BV 1.005 0.567 1.214 0.643 0.820 0.409 16.27 0.0001
SIZE 14.965 1.335 15.098 1.417 14.846 1.247 4.24 0.0001
MTR 0.189 0.108 0.192 0.106 0.186 0.109 1.32 0.1882
Total assets, revenues, MV of equity (market value of shareholders’ equity), and R&D expenses are in NT million dollars. Debt ratio = total liabilities total
assets. ROA = earnings before interest and taxes total assets. ROE = net income book value of shareholders’ equity. Taxable status = 1, if firms have
positive tax liabilities; 0 for none.
RDI = R&D expenses sales;
FUND (+) = pre-R&D cash flow, measured as (operating cash flow + R&D expenditure + current tax expense) net sales;
MV/BV (+) = ratio of market-to-book value, measured as (market value of common stock + preferred stock + total liabilities) total assets;
POST = indicator variable set to 1 if the sample year is 2002 and later; and
HITECH = indicator variable set to 1 if the firm is in the high-tech industry.
#
The mean value is calculated by restricting ROE to ±1, to avoid extreme values’ distortion.
An important advantage of the Taiwanese data used in this study is that the definition of R&D expenses for both financial
reporting purposes and tax returns is generally the same; i.e., expenses for both research and development are qualified for
R&D credits.26 This book-tax conformity contrasts with the U.S. where the tax credit is based on ‘‘qualified research and exper-
imentation” expenditures whereas the financial statements report expenses for ‘‘research and development.” To empirically test
26
However, there are some minor restrictions on certain R&D expenses to qualify for the R&D tax credit. For example, salaries of only full-time R&D personnel
qualify for the tax credit. Such restrictions may cause some differences between R&D expenses reported for book and tax purposes.
High-Tech
R&D Spending
Non-high Tech
Year
Fig. 1. Mean R&D spending during 1996–2003 for high-tech vs. non-high tech firms.
the extent of book-tax conformity in the R&D expense numbers in our sample, we obtained tax return data from the Taiwan tax
authorities. These data were provided only in aggregate for a partial sample of firms to maintain confidentiality. After restricting
our sample to between the 10th and 90th percentiles of R&D intensity,27 the mean (median) difference in R&D intensity calcu-
lated based on financial statement data and tax return data is 3.5% (0.62%). Table 2 summarizes descriptive statistics of the dif-
ference in R&D spending and R&D intensity calculated using financial statement and tax return data. Hence, the data in our
study overcomes a significant limitation of most prior studies that use publicly available data from U.S. firms’ financial state-
ments. As the GAO (1996) concluded, the U.S. studies do not provide reliable estimates of the incentive effects of the credit
because the financial statement data are not a suitable proxy for tax return data.
Although our data have the above-noted advantages over previous research, they are also limited to two years before and
after the credit change. We limited the sample to the shorter time period as we would have encountered difficulty in main-
taining integrity and consistency in extending the data to other sample years due to the lack of access to additional tax return
data and limited survey resources. Nevertheless, as a robustness check, we collected financial statement data and extended
the sample to 2005 with similar results (untabulated).
5. Empirical results
5.1. Descriptive statistics
In untabulated data we examined summary statistics of R&D spending by industry and year from 1996–2003. Noticeably,
among all industries, the electronics (high-tech) industry consistently has the highest average and aggregate R&D expendi-
tures, as well as the highest average R&D intensity. Also as expected, industries such as wholesale and retail trade, tourism,
and cement manufacturers have the lowest R&D intensity. Figs. 1 and 2 depict the differences between the high-tech and
non-high tech firms in the mean and sum of R&D spending, and Fig. 3 depicts the differences in R&D intensity. As shown,
the growing trend of R&D in the high-tech industry exceeds non-high tech industries, consistent with the notion that the
high-tech industry likely has more innovation and growth opportunities.
Table 3 presents the sample firms’ profiles. Panel A reports total assets, annual revenues, market values of shareholders’
equity, R&D spending, debt ratios, and profitability. About 72% of the sample firms have a tax-paying status. In addition, it
appears that our sample has some very large firms as the means of assets, revenues and market value are greater than the
75th percentiles of these variables. Hence, we also include an additional control for firm size in the regression model besides
scaling R&D expenses by sales. Panel B of Table 3 presents descriptive statistics of the regression variables for all sample
firms, as well as separately for the high-tech and non-high-tech subsamples. As expected, the high-tech firms’ R&D expenses
and R&D intensity are significantly greater than those of the non-high tech firms. However, the high-tech firms also appear to
be larger and have more internal funds available than non-high tech firms; thus, additional multivariate testing is needed to
determine the direct effect.
27
Restricting the sample to lie between the 10th and 90th percentiles avoids the influence of extreme values. For example, the year 2001 sample originally
has 523 observations. The original maximum value of the difference in RDI (D_RDI) is about 438 while the 95th percentile value is about 1.74 and the median
value is about 0.0062. Without any restriction, the maximum value would increase the mean D_RDI by 0.84, demonstrating the large influence of this extreme
value on the relatively small sample.
High-Tech
R&D Spending
Non-high Tech
Year
Fig. 2. Sum of R&D spending during 1996–2003 for high-tech vs. non-high tech firms.
High-Tech
Mean RDI
Non-high Tech
Year
Fig. 3. Mean R&D intensity during 1996–2003 for high-tech vs. non-high tech firms.
5.2. Regression results for testing the effect of the increased credit rates on R&D spending (H1a and H1b)
Table 4 presents empirical results of the year and firm fixed effects regression models of R&D intensity for the full sample,
and separately for sub-samples of high-tech and non-high tech firms.28 Consistent with our Hypothesis H1a, the coefficient on
POST MTR is significantly positive, implying that firms able to use the credit are more likely to increase their R&D spending in
response to the 2002 increase in the credit rate. The coefficient on MTR is negative. However, since MTR is included in the
regression twice (a7MTR + a8POST MTR), its magnitude is equal to a7 + a8 POST. Prior to the 2002 credit rate increase
(when POST equals 0), the magnitude is equal to just a7 or 0.0116. However, in the post-2002 period (when POST equals
1), the magnitude effect of MTR is equal to 0.0074 (0.0116 + 0.0190), and the F-value for testing a7 + a8 = 0 is 3.59 (p-
value = 0.0582). Together these results suggest that the marginal effect of MTR after the credit rate increase is significantly pos-
itive and the overall MTR effect after 2002 is also significantly positive.
Consistent with our Hypothesis H1b, the coefficient on POST HITECH is significantly positive in the full sample regression,
indicating that the increase in the credit rate in 2002 has a greater effect on increasing R&D spending of high-tech firms than
28
The Hausman v2 statistic for testing the consistency of random effects estimation of the three models are 272.48 (p-value < 0.0001), 134.93 (p-
value < 0.0001), and 167.22 (p-value < 0.0001), suggesting the random effects models may be inconsistent. Accordingly, we only report the fixed-effects
estimation results.
Table 4
Year and firm fixed-effects regression results of R&D intensity models.
Variables All firms High-tech firms Non-high tech firms

(N = 2034) (N = 955) (N = 1079)
Coeff. t-stat. p-value Coeff. t-stat. p-value Coeff. t-stat. p-value
Intercept N/a N/a N/a N/a N/a N/a N/a N/a N/a
mRDI 0.2153 2.49 0.0129⁄ – – – 0.0337 0.80 0.4241
lagRDI 0.2027 8.64 0.0001⁄ 0.1977 5.90 0.0001⁄ 0.0108 0.34 0.7365
FUND 0.0019 0.85 0.3971 0.0062 1.41 0.1589 0.0007 0.47 0.6381
DEBT 0.0007 0.14 0.8873 0.0009 0.11 0.9115 0.0012 0.35 0.7292
MV/BV 0.0014 1.40 0.1610 0.0005 0.28 0.7762 0.0001 0.14 0.8861
SIZE 0.0100 11.09 0.0001⁄ 0.0166 9.83 0.0001⁄ 0.0024 3.99 0.0001⁄
MTR 0.0116 2.86 0.0043⁄ 0.0306 3.75 0.0002⁄ 0.0007 0.29 0.7698
POST MTR 0.0190 3.81 0.0001⁄ 0.0421 4.14 0.0001⁄ 0.0031 1.01 0.3128
POST HITECH 0.0026 2.54 0.0112⁄ N/a N/a N/a N/a N/a N/a
Firm fixed-effects Yes Yes Yes
Year fixed-effects Yes Yes Yes
R2 0.9356 0.9290 0.9347
F-value 3.30 3.57 4.12
p-value 0.0001 0.0001 0.0001
POST = indicator variable set to 1 if the sample year is 2002 and later;
HITECH = indicator variable set to 1 if the firm is in the high-tech industry;
POST MTR (+) = interaction of POST and MTR; and
POST HITECH (+) = interaction of POST and HITECH.
*
Significance at 0.05 level.
non-high tech firms. In addition, the coefficient on POST MTR is significantly positive in the high-tech sample regression but
insignificant in the non-high tech sample regression. These results suggest that the increase in the credit rate has a positive
effect on the spending of high-tech firms with taxable status, allowing them to claim the benefit of tax credits, but does not
have the same positive effect on non-high tech firms. Although the purpose of raising the R&D credit rate is to increase invest-
ment in R&D, its effectiveness depends on two conditions: (1) firms’ tax status which allows them to claim the benefit of tax
credits, and (2) firms’ profitable innovation opportunities which provide them the incentive to increase investment in new
R&D projects. Therefore, growth and innovation opportunities in the industry also play an important role for the R&D credit
to be an effective tax incentive in stimulating incremental R&D spending. Although non-high tech firms’ tax status may allow
them to claim the tax credits, they may not have sufficient innovation opportunities to increase R&D investment.
The differences in innovation opportunities between the high-tech and non-high tech firms may be exemplified by the
ratios of market-to-book value, a proxy commonly used for growth opportunities. The average MV/BV ratios for the high-
tech and non-high tech samples are about 1.21 and 0.82, respectively, and the t-statistic for testing the difference between
the two groups’ ratios is 16.27 (p-value < 0.0001), suggesting high-tech firms are more likely to have greater growth oppor-
tunities than non-high tech firms. To validate this contention, we replace POST HITECH with POST MV/BV in the full
regression model and add this variable to the high-tech and non-high tech subsample regressions. The coefficients on
POST MV/BV are significantly positive in the full and high-tech regressions (t-statistics of 2.34 and 1.87), but insignificant
in the non-high tech regression (t-statistic of 1.46). The results for the other variables are qualitatively similar to those in
Table 4. Overall, the results lend support to our Hypothesis H1b that the increase in R&D tax credit rate has a greater effect
on the R&D expenditure of high-tech firms than non-high tech firms, ceteris paribus.
Finally, the results of the control variables are generally consistent with our expectations. The coefficients on both mRDI
and LagRDI are significantly positive, supporting the industrial organization theories that firms’ R&D spending is affected by
industry competition and the multi-period nature of R&D investments.29 The results also show that R&D intensity is nega-
tively associated with firm size in all the regression models using the full, high-tech, and non-high tech samples, suggesting
29
To control for the potential endogeneity of LagRDI, we use a two-step regression approach. First, we estimate RDI by the following model (omitting
subscripts i and t for simplicity): RDI = a + mRDI + FUND + DEBT + MVBV + SIZE + MTR + HITECH + Y00 + Y01 + Y02 + Y03 + e, where Y00 to Y03 represents the
sample year of 2000–2003, and the other variables are as defined before. The lagged variable of estimated RDI values from the above regression model is used to
replace LagRDI in model (1). The untabulated results of the panel data regression using the two-step estimation approach are qualitatively similar to those
reported in Table 4. The coefficient on POST MTR is significantly positive in the full and high-tech samples but insignificant in the non-high tech sample.
larger firms tend to be more mature and thus may not increase R&D spending proportionately with sales growth.30 However,
the coefficients on both financial variables, DEBT and FUND are insignificant.
5.2.1. Economic significance of the effects of the increased credit on R&D spending
To evaluate the economic significance of the above results, we calculate the magnitude effects of the increased credit on
R&D spending based on the regression coefficients in Table 4. The regression coefficients of POST MTR in the high-tech and
non-high tech samples are 0.0421 and 0.0031, respectively. These coefficients represent the marginal effects of increasing
R&D intensity (R&D/Sales) for firms with sufficient tax payable to use the R&D credit after the changes in the tax law.
The mean sales (mean MTR) of the post-increased rate years (2002–2003) is NT $12,866 million (0.1875) for the high-
tech sample and NT $6973 million (0.1849) for the non-high tech sample. The average increase in R&D spending for those
firms with sufficient tax payable to use the R&D credit after the changes in the tax law is about $101.56 million
(=$12,866 million 0.1875 0.0421) for high-tech firms and $4.00 million (=$6973 million 0.1849 0.0031) for the
non-high tech firms. In percentage terms, these increases in the dollar amount of R&D spending are about 27.57%
(=101.56 m/368.40 m), and 6.45% (=4.00 m/61.99 m) of the mean R&D expenditure for high-tech firms and non-high tech
firms, respectively.31 These results corroborate the expectations that high-tech firms are far more responsive to the increase
in credit rates than non-high tech firms.
To illustrate the economic significance of the credit-induced R&D spending, we calculated the cost-effectiveness of the
credit-induced R&D spending for our sample firms during 2002–2003. Based on the above calculation, we estimated the total
increased R&D spending in 2002 and 2003 in response to the credit rate increase to be about NT $53,789 million. Based on
the actual credit rates and firms’ R&D expenditures in 2002 and 2003, we calculated the total dollar amount of R&D credit of
the sample for 2002 and 2003 to be about NT $79,595 million. We then calculated the estimated total dollar amount of R&D
credit if the credit rates would have remained the same as in 2001, based on firms’ forecast R&D expenses in 2002–2003.32
The estimated total dollar amount of R&D credit of the sample for their R&D expenditures of 2002 and 2003 would be NT
$65,843 million. The tax revenues foregone due to the five-percentage increase in the credit rate are about NT $13,752 million
($79,595 million $65,843 million). Therefore, the increased-credit rate induces on average $3.91 ($53,789 $13,752) of
additional R&D spending per dollar of revenue foregone in Taiwan. The magnitude of credit-induced R&D spending is quite
significant, probably due to the large high-tech sector in Taiwan, which comprises nearly half of our sample firms.
5.3. Model specification and sensitivity tests
The primary challenge to our overall conclusions that the credit rate increase in 2002 had a significantly positive effect on
R&D spending and that this effect was greater for firms in the high-tech sector is whether our empirical tests are able to sep-
arately identify the effects of the credit change from alternative explanations, such as a general upward time pattern or prof-
itability. We address these concerns in multiple ways. First, we noted that our dependent variable in the regressions is R&D
intensity (RDI), which is R&D expenses scaled by sales. Since sales grow as the firm grows, we expect RDI to control for an
inherently increasing trend in R&D expenses over time. Second, we estimated the regressions using year and firm fixed
effects panel data methods, which includes an additional control for time effects.33 Third, in calculating predicted RDI used
to estimate tax revenue losses, we included the coefficients of the year intercepts (time effects obtained from the regression)
in the estimations (e.g., year2000 intercept = 0.0036; year2001 = 0.0054; year 2002 = 0.000041). Fourth, we examined whether
high MTR firms have an increasing trend in R&D expenses relative to other firms by splitting the sample into high-MTR
(MTR > 0) and low-MTR (MTR = 0) firms and then calculating their mean RDI for each sample year. Other than the year
2000, the RDI of these two groups is not significantly different in any year. Together these tests suggest that time effects are
unlikely to be commingled with the marginal tax rate proxy.
Notwithstanding these controls, the fact remains that our setting does not involve the ideal experiment, which, for exam-
ple, would have included both increases and decreases in the tax benefit. Hence, as an additional robustness test of the effect
of increased tax credit rates on R&D spending, we estimated change models of RDI in a pre-post credit rate change design.
Finally, to examine some of the key alternative explanations for our results, we estimated the levels model with additional
controls for profitability and discuss these results below.
30
Since the dependent variable RDI uses sales as a scalar and the independent variable SIZE is measured as the natural log value of sales, the negative
coefficient of SIZE in the regression results could be due to a mathematical relationship, i.e., the larger the sales, the smaller the ratios of R&D to sales. Therefore,
we replace SIZE with an alternative measure SIZE_A, defined as the natural log value of total assets. The coefficients on SIZE_A remain significantly negative in
the full and high-tech sample regressions (t-statistics of 1.81 and 1.91, respectively), but insignificant in the non-high tech sample regression. The
coefficients and significance levels of other variables are not qualitatively different from those in Table 4. Thus, the negative relationship between R&D intensity
and firm size is not purely mechanical.
31
Similarly, the average increase in R&D spending for all firms after the changes in the tax law is about $34.67 million (=$9805 million 0.1861 0.0190),
which is about an increase of 16.84% (=34.67 m/205.86 m) of the mean R&D expenditure.
32
The forecast R&D expense is calculated by using the regression coefficients of independent variables and individual firms’ intercept from Table 4, multiplied
by the value of corresponding independent variables in 2002–2003.
33
In addition to the year and firm fixed-effects panel data method, we have also tried to use the firm fixed-effects panel data method and control for the
effects of firms’ capital asset intensity and national economic growth and cost of borrowing in the regression models. The results remain robust to the
alternative panel data method and model specifications.
5.3.1. Testing the effect of the increased credit rates using change models
Table 5 presents regression results of change models calculated as the differences between mean values of the regression
variables before and after the increased credit rates, with two differences from the level models – we dropped lagged RDI and
used the mean value of MTR instead of the change in MTR. Change models have the advantage of differencing out individual
heterogeneity and serial-correlation problems. The results show that the coefficients on MTR become positive in all three
models and are significant in the full sample and the high-tech regressions, consistent with our expectation. The results
for the other variables are similar to the levels models. Note that the F-value for the non high-tech sample regression is
0.73 (p-value = 0.6243), suggesting the model specification is not fit for this sample.
5.3.2. Controlling for profitability

It is possible that our MTR variable, which proxies for firms’ taxable status, simply captures firms’ profitability. Hence, we
re-estimated the regression models by adding lagged return on assets (ROA) to specifically control for profitability. ROA is
measured as earnings before interest and taxes, scaled by total assets. The untabulated results show that the coefficient
on ROA is significantly positive in the full and high-tech sample regressions, but insignificant in the non-high tech sample
regression. Further, the coefficients on the two interactions of interest remain significant as before: POST MTR is 0.0164 (t-
stat = 3.30, p-value = 0.001), and the coefficient on POST HITECH is 0.0021 (t-stat = 2.08, p-value = 0.0374). The coefficients
and significance levels of other variables do not differ qualitatively from those in Table 4. Therefore, our results also suggest
that profitable firms are likely to invest more in R&D, consistent with the findings of Swenson (1992).
5.3.3. Alternative measurement of marginal tax rate

To test the model sensitivity for MTR, we adopt an alternative measurement of MTR (MTR_BK) by referring to the tax rate
measure of Brown and Krull (2008). We define MTR_BK equals 0.25 if the firm has (1) positive taxable income in year t and
(2) no net operating loss carry-forward from year t 1, 0.125 if the firm has (1) or (2), and 0 if the firm has both (1) and (2).
We then re-estimate the regression models by replacing MTR by MTR_BK. The untabulated results show that the coefficient
on MTR_BK is negative and the coefficients on POST MTR_BK in the all firm and high-tech firm samples remain positive (t-
statistics of 6.07 and 4.41, respectively). Also, the coefficient on POST HITECH in the all firm sample remains positive (t-
statistic of 1.77). The coefficients on MV/BV, however, become significantly positive in the all firm and high-tech firm samples
(t-statistics of 1.78 and 2.89, respectively), which is consistent with our expectation. The coefficients and significance levels
of other variables do not differ qualitatively from those in Table 4. Therefore, the results suggest that our regression models
are robust to the alternative measurement of MTR.
5.4. Test results for the change in the R&D credit’s structure in 2000 on firms’ R&D spending patterns and revenue collections (H2)
5.4.1. Test results for variability in firms’ R&D spending due to the 2000 amendment (H2)
The 2000 amendment of the Statute for Upgrading Industries grants a 50% tax credit for the excess of R&D spending over
the previous two years’ spending average. To increase the qualified R&D spending for the 50% credit rate, a firm may either
Table 5
Regression results of changes in R&D intensity models.
Variables All firms High-tech firms Non-high tech firms

(N = 530) (N = 255) (N = 275)
Coeff. t-stat. p-value Coeff. t-stat. p-value Coeff. t-stat. p-value
Intercept 0.0033 2.34 0.0198⁄ 0.0082 2.73 0.0069⁄ 0.0012 1.25 0.2126
mRDI_d 0.0197 0.18 0.8568 1.5665 2.15 0.0329⁄ 0.0101 0.18 0.8577
FUND_d 0.0003 0.06 0.9487 0.0009 0.13 0.8981 0.0038 1.33 0.1841
DEBT_d 0.0108 1.38 0.1684 0.0141 1.13 0.2576 0.0059 0.89 0.3730
MVBV_d 0.0023 1.84 0.0657⁄ 0.0030 1.37 0.1726 0.0003 0.23 0.8184
SIZE_d 0.0089 6.52 0.0001⁄ 0.0151 6.39 0.0001⁄ 0.0009 0.86 0.3879
MTR_m 0.0230 3.31 0.0010⁄ 0.0519 3.59 0.0004⁄ 0.0049 1.10 0.2732
R2 0.0897 0.1789 0.0161
Adj R2 0.0792 0.1590 0.0059
F-value 8.59 9.01 0.73
p-value 0.0001 0.0001 0.6243
The regression variables are calculated by taking the differences in the mean values of the variables between 2002–2003 and 2000–2001 and indicated by
‘‘_d” added to the variable name. MTR_m is the mean value of MTRs.
SIZE (?) = firm size, measured as the natural log of net sales; and
MTR (+) = marginal tax rate.
*
Significance at 0.05 level.
postpone the previous year’s R&D spending or expedite next year’s spending to the current year, thereby increasing the vari-
ability in its annual R&D spending.
To test whether the variability in R&D spending and R&D intensity increases with the enactment of the 50% credit rate for
incremental R&D, we form the test samples for the pre- and post-2000 periods separately. The pre-2000 period covers the
years from 1996 to 1999, and the post-2000 period covers those from 2000 to 2003. The sample firms in the pre- or post-
2000 periods must have four consecutive year observations (i.e., a balanced sample). Our test sample consists of 266 firms
(266 4 = 1064 firm-year observations) for the period 1996–1999 and 539 firms (539 4 = 2156 firm-year observations) for
the period 2000–2003.
We conjecture that if firms take measures to time their R&D spending to obtain additional tax credits in response to the
2000 amendment, the variability in firms’ R&D spending will have become greater after the enactment of the 2000 amend-
ment. Further, if firms opportunistically time their R&D spending to obtain the 50% incremental credit, their actual spending
pattern will deviate more from the predictable patterns, resulting in greater forecast errors in R&D expenses in the post-2000
period. Finally, the effect of strategic timing may result in a portion of firms obtaining the incremental credit that they would
otherwise not qualify for. Accordingly we conduct the following three related tests:
1. Standard deviations tests for pre- and post-2000 periods: We compute the standard deviations of both R&D intensity
(RDI) and R&D expense (RD) for each firm during the two periods, 1996–1999 and 2000–2003 separately, and compare
the mean standard deviations of RDI and RD between pre- and post-2000 periods. We conjecture that the mean standard
deviations of RDI and RD are greater in 2000–2003 than in 1996–1999.
2. Forecast errors tests for pre- and post-2000 periods: We compute forecast R&D using the regression coefficients of inde-
pendent variables and individual firms’ intercepts from Table 4,34 and compare the mean forecast errors of R&D intensities
(D_RDI) and R&D expenses (D_RD) between pre- and post-2000 periods. The forecast errors of D_RDI and D_RD are calcu-
lated by taking the differences between actual and forecast RDI as well as RD. We expect that the mean forecast errors of RDI
and RD are greater in 2000–2003 than in 1996–1999.
3. Incremental credit-qualified firms tests for actual and forecast R&D expenses: We classify firms qualified for the incre-
mental credit as Y50 firms if the firms’ current year’s R&D expenses exceed the average of the prior two years’ R&D
expenses, and calculate the percentage of observations classified as Y50 firms in 2000–2003 based on actual and forecast
R&D expenses, respectively. We then compare the difference in the percentage of Y50 firms between based on actual and
forecast R&D expenses. Because the classification of Y50 firms requires three consecutive year of R&D data (e.g., t, t 1,
and t 2 years) for each firm-year observation, the number of observations used for the test is reduced to 1052 firm-year
observations in the period 2000–2003. We expect the percentage of Y50 firms based on actual R&D expenses to be greater
than that percentage based on forecast R&D expenses if the a portion of firms opportunistically time their R&D spending
to obtain additional tax credit that they would otherwise not qualify for.
Table 6 presents the results of the three tests for Hypothesis H2. Panel A shows that the mean standard deviation of RDI
(RD) is 0.00427 ($35.544 million) in 1996–1999 and is 0.00789 ($55.301 million) in 2000–2003. The t-statistic of difference
in mean standard deviation of RDI (RD) between 2000–2003 and 1996–1999 is 3.74 (1.83), with p-value = 0.0002 (0.0670).
The results indicate that both standard deviations of RDI and RD increased significantly from the period 1996–1999 to 2000–
2003.
Panel B shows that the mean forecast error of D_RDI (D_RD) is 0.00274 (-$47.600 million) in 1996–1999 and is 0.00844
($66.220 million) in 2000–2003. The t-statistic of difference in mean forecast error of D_RDI (D_RD) between 2000–2003 and
1996–1999 is 12.87 (9.23), with p-value < 0.0001 (<0.0001). We also take the absolute value of the forecast errors and per-
form the same tests. The results remain the same. The mean absolute value of forecast errors of D_RDI (D_RD) is 0.00416
($26.625 million) in 1996–1999 and is 0.00943 ($75.115 million) in 2000–2003. The t-statistic of difference in mean absolute
forecast error of D_RDI (D_RD) between 2000–2003 and 1996–1999 is 8.44 (7.28), with p-value < 0.0001 (<0.0001). The
results suggest that both forecast errors of D_RDI and D_RD increased significantly from the period 1996–1999 to 2000–
2003.
Panel C shows that the percentage of observations classified as Y50 firms is 0.4553 (a total of 479 firms) based on actual
R&D expenses and is 0.3298 (a total of 347 firms) based on forecast R&D expenses. The t-statistic of difference in the per-
centage of Y50 firms for based on actual and forecast R&D expenses is 6.98, with p-value < 0.0001. The results show that
the percentage of Y50 firms based on realized R&D spending is significantly greater than that percentage based on forecast
spending. The result is consistent with the notion that a significant portion of firms may strategically time their R&D spend-
ing to obtain the 50% incremental credit that they would otherwise not qualify for.
Taken together, these results are consistent with our Hypothesis H2 that firms opportunistically time their R&D spending
patterns to obtain additional tax credits, resulting in greater variability as well as forecast errors in R&D spending.35
34
Forecast RDI = Individual firm’s intercept + 0.2153 mRDI + 0.2027 lagRDI 0.0019 FUND + 0.0007 DEBT + 0.0014 MV/BV 0.01 SI-
ZE 0.0116 MTR. Forecast R&D expenses = Forecast RDI Sales.
35
We also conduct the standard deviations tests and the forecast errors tests for pre- and post-2000 periods using a balanced panel across the two periods.
The sample is reduced to 263 firms for both 1996–1999 and 2000–2003 periods. The two tests results using such a balanced panel remain qualitatively the
same as those in Table 6.
Table 6
Test results of variability in firms’ R&D spending and R&D intensity before and after the 2000 amendment of the Statute for Upgrading Industry.
1996–1999 (N = 1064a) 2000–2003 (N = 2156b) t-test for testing

H0: l2000–2003 = l1996–1999
Variables Mean of std. dev. Mean of std. dev. t stat. p-value
Panel A: t-test results on mean differences in standard deviations of RDI and RD between 1996–1999 and 2000–2003
RDI 0.00427 0.00789 3.72 0.0002
RD (in million) 35.544 55.301 1.83 0.0670
Variables 1996–1999 (N = 1064) 2000–2003 (N = 2156) t-test for testing

H0: l2000–2003 = l2000–2003
t stat. (p-value) for
Mean |Mean| Mean |Mean| Mean |Mean|
Panel B: t-test results on mean differences in R&D forecast errors between 1996–1999 and 2000–2003
D_RDI 0.00274 0.00416 0.00844 0.00943 12.87 (0.0001) 8.44 (0.0001)
D_RD (in million) 47.600 26.625 66.220 75.115 9.23 (0.0001) 7.28 (0.0001)
Based on actual RD Based on forecast RD t-test for testing
(N = 1052) (N = 1052) H0: lActual RD = lForecast RD
% No. % No. t stat. p-value
Panel C: t-test results on difference in percentage of Y50 firms based on actual and forecast R&D expenditures in 2000–2003
Y50 firms 45.53% 479 32.98% 347 6.98 0.0001
RDI = R&D intensity = R&D expenses sales.

RD = R&D expenses.
D_RDI = difference between actual and forecast R&D intensity.
D_RD = difference between actual and forecast R&D dollar amount.
|Mean| = mean absolute value of D_RDI or D_RD.
Forecast values are calculated using the regression coefficients as well as the individual firms’ intercepts from Table 4.
Y50 firms: firms’ current year’s R&D spending > average of prior two years’ R&D spending.
a
266 firms 4 years.
b
539 firms 4 years.
5.4.2. The impact of strategically timing R&D spending on aggregate tax revenues
A potentially important unintended economic consequence of firms strategically timing their R&D spending to increase
R&D tax credits is to reduce tax revenue collections. Accordingly, we use the sample for the test in Panel C of Table 6 and
calculate the actual tax credit based on the actual R&D spending and the statutory credit rates during 2000–2003, as well
as the forecast tax credit based on the forecast R&D spending and the statutory credit rate during that period. The actual
credit amount is about NT $102,199 million. By comparison, the forecast credit amount is about NT $69,992 million. There-
fore, using the forecast value as a benchmark, we estimate the additional tax revenue loss to the government at NT
$32,207 million, or about 2.35% of actual corporate tax collections during 2000–2003.36
6. Conclusion
Taiwan’s R&D tax policy is generous and unique. Unlike the straight tax credit in Canada and the strictly incremental tax
credit in the U.S., Taiwan provides a hybrid of a base tax credit on each dollar of R&D spending and an additional credit for
incremental R&D spending over a moving average base. Our empirical analysis using firm-level data from Taiwanese com-
panies covering the time period during which the base credit was significantly increased and the incremental credit was first
enacted, allows us to inform the long-standing policy debate on the role of tax incentives on firms’ R&D spending. The results
of our analysis also benefit from an inherent advantage of our data: the R&D expenses reported on tax returns in Taiwan
conform closely with the expenses reported on financial statements, thus avoiding the data problems that have plagued
most of the studies based on U.S. data where there are substantial disconformities between the two sets of numbers. Finally,
Taiwan’s emerging economy with its large high-tech sector allows a clearer analysis of the role that innovation and techno-
logical opportunities play in the impact of tax incentives on firms’ R&D spending.
Our study has two main takeaways. First, our regression results indicate that, after controlling for both tax and non-tax
factors, the increase in the R&D tax credit rate has a positive effect on the R&D spending of high-tech firms, but not on the
R&D spending of non-high tech firms. These results suggest that abundant tax incentives alone may not be sufficient to
achieve the stated policy goal of stimulating additional R&D investment. Innovation opportunities in the industry may play
a more important role for firms to respond to the tax incentives.
Second, we find that the structure of the credit has important implications for firms’ R&D spending patterns. Our results
show that tax incentives linked to incremental R&D spending based on a moving average base appear to induce firms to
36
$102,199 million $69,992 million = $32,207 million. The total corporate tax revenues during 2000–2003 are about NT $1,371,700 million.
opportunistically time their spending patterns in order to maximize their tax credits. To the extent aggregate spending over
that time period is unchanged, the unintended effect of such timing could be a higher than expected loss in tax revenues. The
U.S. R&D tax credit when originally enacted was similarly based on incremental expenses over a moving average base. Fol-
lowing heavy criticism that the moving average base could result in zero or negative effective credit rates and thus severely
limit the tax incentive’s effect to stimulate research activity (e.g., Eisner et al., 1984; Altshuler, 1988), the U.S. credit structure
was modified by the Omnibus Budget Reconciliation Act of 1989 to a fixed base percentage. Our results provide empirical
support for the change.
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Journal of Contemporary Accounting & Economics 13 (2017) 52–68

Contents lists available at ScienceDirect

The incentive effects of R&D tax credits: An empirical

4.1. Regression model of R&D spending

Tax status at year t 1

4.2. Sample selection and data

Panel A: Sample selection procedures

Year Firm-years Percentage of sample

Industry Firm-years Percentage of sample

5.1. Descriptive statistics

Variables All firms High-tech firms Non-high tech firms

5.3. Model specification and sensitivity tests

5.3.2. Controlling for profitability

5.3.3. Alternative measurement of marginal tax rate

Variables All firms High-tech firms Non-high tech firms

1996–1999 (N = 1064a) 2000–2003 (N = 2156b) t-test for testing

Variables 1996–1999 (N = 1064) 2000–2003 (N = 2156) t-test for testing

RDI = R&D intensity = R&D expenses sales.

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