A taxing problem hits European R&D

 

As the countries of the European Union struggle to meet their targets for R&D growth, they are looking at new tax breaks for entrepreneurs. Good news, or too little too late?

Five-and-a-half years ago Philippe Giraudeau and fellow academic Richard Lallemant set up Aair Lichens, a small company based just outside Nantes, in northwest France. It uses lichens that grow on tree bark to measure and map pollutants in the air. It has registered several patents and trademarks – just the sort of outfit that governments in Europe and beyond claim to want to help.

But Giraudeau has shunned most tax break schemes offered by the French government. “There is a scheme we can benefit from but the calculations are so bizarre,” he says.

France, he says, is not a great place for entrepreneurs like him. “There are too many costs and not enough encouragement from the government,” he says. There is a time lag between paying the tax and being reimbursed by the state. “I know start-ups like ours that have gone bust in the meantime.”

Lack of support

Aair Lichens’ situation illustrates a problem felt in many parts of Europe. A lack of government support, whether directly through subsidies or indirectly using tax breaks, has allowed other parts of the world including the United States and Japan to lead the way in developing cutting edge technologies. As a result, there’s a growing consensus around Europe that tax breaks can help boost R&D – especially at small companies. And so policy analysts from Paris to Stockholm are studying new programmes, and nursing old wounds.

For instance, Gunter Verheugen, the German vice president of the European Commission in charge of enterprise and industry, holds up the digital music industry as an example of Europe missing its R&D potential.

“The MP3 audio standard that operates millions of iPods and other music players around the world was developed at the Fraunhofer Institute in Erlangen, Germany, but the profits were mainly enjoyed in the United States,” he said in an interview earlier this year.

Benefits

There is little doubt about the beneficial effects from governments reducing the cost of research for companies. A 10 per cent fall in the cost of research results in a 10 per cent increase in the amount of research carried out in the long term, said John Van Reenen a professor at the London School of Economics and a director of the London-based Centre for Economic Performance.

He reached this conclusion after conducting research in eight countries over a 16-year period. There is also a lot of evidence showing the benefits of R&D on the economy. “Not just through the benefits felt by the companies that do the research themselves but also because other companies benefit off the back of the research,” he said.

The French government appears to have seen the light. Last year it introduced the Jeune Entreprise Innovante (Young Innovative Company) scheme, which allows big reductions in income tax and social security payments for start-ups younger than eight years old that devote a minimum of 15 per cent of overall costs to research and development.

’Star pupil’

Unlike the complicated and meagre schemes dismissed by Giraudeau, this new plan to boost French R&D investment has been welcomed by parts of industry. Johan Vanhemelrijck, secretary general of the Europe-wide biotech industry association EuropaBio, said that in the space of a year France has gone “from the bottom of the class to become the star pupil”, and he is lobbying the European Commission to adopt the ‘young innovative companies’ definition Europe-wide.

The main definition used at a European level to pinpoint companies in need of a boost from the state has been the small- and medium-sized enterprise (SME). But this focus on size excludes innovators such as ambitious biotech start-ups, which sometimes launch with as much as €200 million in seed capital from venture capitalists, Vanhemelrijck said.

France has joined a growing number of countries in Europe and beyond that are using volume-based tax break schemes instead of incremental schemes, which only reward companies for spending more in a year than they did the previous year.

It can be simple

The best examples, according to most experts, can be found in the UK and Holland. In the UK the process of claiming a tax credit is very simple, said Bruno van Pottelsberghe, a former lecturer at the Solvay Business School in Brussels who is about to take up the job of chief economist at the European Patent Office in Munich.

“Companies do it themselves in their tax returns, and tax inspectors are well trained to deal with the credits. It’s the most business-friendly system in Europe. When you look at small start-ups in the UK, the benefits are visible,” he said.

In Holland, innovative companies benefit from reductions in the social security they must pay for employees involved in R&D. “The companies benefit not at the end of the year, but each month. That’s excellent for small companies with cashflow problems,” van Pottelsberghe said.

Belgium, on the other hand, remains wedded to an incremental tax credit scheme. “Tax credits are linked to increases in R&D and this can induce a perverse effect,” van Pottelsberghe said. Companies get a tax credit when they employ a new person to conduct research. In addition to being complicated, the system could encourage firms to hire and fire researchers quicker than they would normally do, he said.

“Companies cannot continue to increase their research budgets indefinitely. The schemes are tricky to administer and the bottom line is that they offer much less to companies than a volume-based scheme. What they offer is peanuts.”

Short-sighted Germany

But peanuts is better than nothing at all. Germany and Finland don’t use tax breaks to boost R&D spending by their companies at all, which is short-sighted, according to Gerhard Beutin, head of financial affairs at the German Research Centre for Biotechnology.

His institute is 90% owned by the German state and 10% owned by the region of Lower Saxony, yet 90% of its funding comes from private sources such as the Bill & Melinda Gates Foundation.

The reason Germany, Europe’s largest economy doesn’t offer tax breaks in return for R&D investment by companies is political, Beutin said. For years, the country has had one of the highest levels of tax in Europe but also one of the most porous fiscal regimes on the continent, with numerous exemptions and tax breaks.

In the past five years the government has vowed to clamp down on these ways around the tax burden, largely because the country has one of the worst budget track records in the EU. It repeatedly breaks the EU-wide budget deficit ceiling of 3 per cent of gross domestic product.

The brain drain

Some specific industries do get R&D support from the government but there is no sign of any general tax reduction plan for Germany’s innovators. The result is a brain drain, as the smartest scientists in Germany are tempted to go and work abroad, said Beutin.

Van Reenen was sceptical about efforts at a European level to boost R&D. “The state aid rules already grant an exemption for public spending that goes into R&D,” he said.

He said there was nothing wrong with the Commission looking around Europe at best practices on tax breaks, he said. It may encourage countries like Belgium to switch from incremental tax break schemes to the volume-based ones employed in countries like the UK, Spain, Holland, and more recently France. But he warned against trying to forge EU-wide legislation. “A one size fits all policy would be a bad idea,” he said.

There is a growing consensus that well-crafted tax incentives play an important role in getting Europe’s moribund economy back on its feet. But whether it will ever be enough to make French scientist-entrepreneurs like Giraudeau more ambitious is yet to be seen.