The Government's flagship research and development (R&D) tax credit scheme is failing to spur business innovation and investment in science and technology, a damning report by the Centre for Business Research at Cambridge Judge Business School concludes.
The paper, authored by senior research associate David Connel, challenges the Treasury's assertion that every £1 of R&D tax credits generates between £2.40 and £2.70 of R&D spending.
Instead, Connel quotes data gathered from the Office for National Statistics that suggests that while the cost of the credit is equivalent to 25% of all UK R&D spending, the amount of R&D funded by companies' earnings is 10-15% lower than when the scheme was introduced.
"At this rate, the level of business R&D needed for the Government to meet its target of 2.4% of GDP being spent on R&D can never be achieved", reads the report.
In a foreword to the paper, MP Greg Clark, chairman of the Select Committee for Science and Technology, said: "The paper makes a powerful case for looking again at R&D tax credits."
By 2020, R&D tax credits were expected to cost the Treasury £7.3 billion per annum, dwarfing the value of grants handed to companies by the Industrial Strategy Challenge Fund by a factor of 14.
R&D tax credit performance
The Blair Government introduced the R&D tax credit scheme for SMEs in 2000 to make up for the failures of previous grant schemes, allowing small businesses to deduct an extra 130% of their qualifying costs from their yearly profit on top of the regular 100% deduction.
In 2002, lawmakers introduced the research and development expenditure credit for larger companies, allowing them to deduct 13% of qualifying R&D costs.
Business expenditure on R&D (BERD) and gross expenditure on R&D (GERD) continued to decline as a percentage of GDP, however, prompting a major science and innovation policy review in 2004.
Following the review, the Government set a target to grow BERD 1.0% to 1.7% of GDP by 2014 and GERD to grow from 1.5% to 2.5%.
And yet, according to the Office for National Statistics, BERD grew to 1.2% of GDP and GERD to 1.7% between 2004 and 2018, far from the original targets.
The 2017 Industrial Strategy White Paper then set a new GERD target of 2.4% of GDP by 2027, a target that Connel claims "can never be achieved" with the current amount of R&D spending.
Reasons for poor performance
The report argues that the low level of UK business R&D and the failure of policy to have an impact rests in the "failure to grow and retain new STEM based UK companies to replace industries in decline", which Connel puts down to two factors.
First, the relatively small size of the UK market means that new British companies tend to grow early revenues slower than similar companies in countries like the US and China, reducing their long-term competitiveness and ability to remain independent.
Second, the attractiveness of the UK as a place to make acquisitions means that early trade sales will usually be to a US or other foriegn multinational, leading to "the truncation of further growth in the UK".
Recommendations
First and foremost, Connel calls for a reduction and refocusing of R&D tax credits to give greater impact.
This includes the £1.1bn patent box scheme, another R&D subsidy, which Connel argues should be abolished as "there is no evidence that the patent box has brought benefits to the UK economy".
Restricting R&D tax credit claims to R&D spending in the UK and ceasing subsidies for financial services because the sector falls outside the internationally accepted definition for measuring business R&D are also on Connel's recommendation list.
The resulting savings can then be reinvested in new policies, he argues, such as a new class of funds to attract entrepreneurs to use venture capital.
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