Are 'Complementary Policies' Substitutes? Evidence from R&D Subsidies in the UK

Abstract

Governments often subsidize private R&D using both direct subsidies and tax incentives. In this paper, I develop a framework for studying their interdependence, which also provides a test for detecting capital market imperfections. I implement two quasi-experimental research designs to examine firms in the United Kingdom and show that grants and tax credits are complements for small firms but substitutes for larger firms. Higher tax credit rates substantially enhance the effect of grants on R&D investment for small firms, particularly those facing financial constraints, but they reduce it for larger firms. The productivity of small firms also increases. My findings imply that the innovation policy mix should include both support mechanisms for small firms only.

Keywords: R&D, innovation, policy interactions, difference-in-discontinuities, regression discontinuity design

JEL Classification: D22, G28, H0, H2, L53, O31, O32, O38