Aiming to boost R&D performance by businesses and drive innovation and economic growth and social well-being, governments use the tax system to provide financial incentives for companies to invest in R&D. This additional investment in cutting-edge knowledge and its applications, which exhibit spillovers and high uncertainty, can provide benefits beyond those that the firms themselves can appropriate and can justify the subsidy.
While governments can also use other instruments such as targeted grants or contracts for R&D services, tax incentives have risen in popularity because they can be designed to let eligible companies choose which R&D projects to invest in. This makes tax support relatively easy to administer and compliant with trade and competition rules that constrain the use of state aid. However, a downside of excess reliance on R&D tax incentives is the reduced scope for targeting R&D funding to specific policy priority areas.