One Trillion Yen Tax Reduction on R&D Investment

TAMADA Schumpeter
Fellow, RIETI

Recent opinion surveys show that what the public desires most of the Koizumi administration is progress in implementing economic structural reforms, but even more a policy for improving Japan's economic climate. If the subject of this article, "Tax Reduction on R&D Investment", was rather "Public Investment," it would have a ring of election sloganeering. Therefore, I will compare the policy effect of tax reduction on R&D investment with that of public investment from the following three perspectives: 1) their effect on short-term economic stimulus, 2) their effect on long-term economic growth, and 3) their effect on advancing structural reform. In so doing, I will argue that tax reduction on R&D investment is more effective in policy terms than public investment from each of these three perspectives.


I will begin by briefly explaining what I mean by "tax reduction on R&D investment." Strictly speaking, this is a system of tax deductions for research and experiment costs. That is, a specified percentage of costs incurred by companies for activities that fall within the definition of "research and experiment" could be deducted from corporate taxes in an amount heretofore not permitted. Stated simply, the more a company invests in R&D, the more it would be able to save in taxes. For small- and medium-scale companies, the system is already established with a clear-cut 10% deduction permitted for research and experiment costs. The problem is with larger corporations, which account for 95% of Japan's in-company research expenses. Due to the complexity of the tax system for these corporations, in recent years their R&D tax deductions have only amounted to a measly 31 billion or so yen, despite an aggregate R&D expenditure of 10 trillion yen. This provides only a 0.31% tax incentive for these companies to conduct in-house R&D. This is way too low an incentive, especially given the fact that large corporations employ and pay the salaries of about half of the people who work in Japanese companies. I believe the tax code should be reformed to allow large corporations to deduct the same across-the-board 10% for R&D that is permitted SMEs. This would effect a tax reduction on a scale of 1 trillion yen. In addition, the definition of "research and experiment" for tax-deduction eligibility should also be extended to business model development and other R&D related to software houses, financial firms, transport companies and other entities of the service industry.

1) Effect on short-term economic stimulus

According to the recent industrial indices of the Ministry of Economy, Trade and Industry, 52% of public investment is being made in highly skewed areas (e.g., 2.1% for gravel and pulverized rock; 3.9% for ready mix concrete; 4.5% for cement products; 3.6% for metal construction products; and 6.6% for wholesaling). Only 30% is invested in salaries and wages. In contrast, salaries and wages paid in the R&D operations of corporations make up over 42.5% of their personnel costs. Therefore, in terms of its effect on advancing employment and stimulating the economy through personal income, R&D tax deduction outperforms public investment.

2) Effect on long-term economic growth

In June 1997, FRB chairman Greenspan stated that when measuring the US's GDP in total tons, it has hardly changed over the past half century, whereas its per ton value has dramatically increased; and that what has caused this, despite no increase in the weight of manufactured goods per se, has been new ideas and knowledge. A "knowledge-based economy" can be said to have emerged when innovation reduces the weight of products that incorporate leading-edge technology and knowledge. R&D is precisely the activity through which knowledge, the foundation of such an advanced economy, is generated. Advancing R&D while accumulating intellectual capital within corporations can become the driving force to achieving long-term economic growth. In contrast, I have not heard how constructing three large bridges between Japan's islands of Honshu and Shikoku has increased productivity or, in turn, led to improved wages.

3) Effect on advancing structural reform

An R&D tax deduction only has merit for companies that are in the black, as those that do not have to pay corporate taxes and, thus, receive no tax incentive from the deduction. Therefore, R&D tax deduction may be considered a system that allows the strong to get stronger and to prey on the weak. On the other hand, it could be a fair system as it places no limitations on competition in that it would support autonomous R&D activities based on the strategy of each corporation. In this sense, the system might also be called a "structural reform promotion tax." On the other hand, as public investment is directed mainly to construction companies, which are said to be less competitive in the world market, it is a system that provides life support to sustain the weak. Clearly, therefore, its effect runs counter to structural reform.


I have shown that a tax reduction on R&D investment is superior in effect to public investment. Regarding revenue sources, if the Japanese government wanted to implement this policy in the current fiscal year, it could by reducing the budget by an overall 1% through administrative initiative, through which it should be possible to cut expenditures by JPY800 billion. This will leave JPY200 billion, which will have to be addressed in other ways. Even increasing the budget deficit by this amount would be warranted given the potential bonanza in increased corporate profits and resultant taxes that a more R&D-friendly tax policy could yield.

May 21, 2002

May 21, 2002

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