FEDERAL RESERVE BANK OF SAN FRANCISCO WORKING PAPER SERIES Beggar thy Neighbor? The In-State, Out-of-State, and Aggregate Effects of R&D Tax Credits

The proliferation of R&D tax incentives among U.S. states in recent decades raises two important questions: (1) Are these tax incentives e¤ective in achieving their stated objective, to increase R&D spending within the state? (2) To the extent the incentives do increase R&D within the state, how much of this increase is due to drawing R&D away from other states? In short, this paper answers (1) “yes” and (2) “nearly all,”with the implication that the net national e¤ect of R&D tax incentives on R&D spending is near zero. The paper addresses these questions by exploiting the crosssectional and time-series variation in R&D tax credits, and in turn the user cost of R&D, among U.S. states from 1981-2004 to estimate an augmented version of the standard R&D factor demand model. I estimate an in-state user cost elasticity (UCE) around 2:5 (in the long-run), consistent with previous studies of the R&D cost elasticity. However, the R&D elasticity with respect to costs in neighboring states, which has not previously been investigated, is estimated to be around +2:7, suggesting a zero-sum game among states and raising concerns about the e¢ ciency of state R&D credits from the standpoint of national social welfare. [