State-Level R&D Tax Credits: A Firm-Level Analysis

California's changes in R&D tax credit rates on biopharmaceutical and software firms' research investment during 1994-1996 and 1997-1999 is compared using two approaches. Consistent with the federal research tax credit literature, the difference-in-differences analysis provides some evidence of increased R&D expenditure in response to research tax credit rate increases. In contrast, the estimated tax price elasticities obtained by computing and testing the tax prices for in-house research are dramatically higher than the existing literature's estimates near unity. Possible explanations include firms' greater sensitivity to state-level policy, industry factors, sample characteristics and measurement error. For contract research with universities and other not-for-profit research organizations, the findings suggest a tax credit may not be the optimal policy tool. Finally, state-level R&D incentives do not appear to have equal incentive effects across industries.