Estimating the impact of the R&D tax credit on strategic groups in the pharmaceutical industry

Abstract

The Economic Recovery and Tax Act of 1981 provided a 25 percent tax credit for increases in research and experimentation expenditures. Previous studies have shown considerable controversy about the effectiveness of various tax credits. This study focuses on the response of the strategic groups in the pharmaceutical industry to the credit. Four strategic groups were formed using different levels of research intensity (research/sales) and relative cash flow margin (cash flow/sales). The change in research intensity following enactment of the tax credit was estimated. The analysis found that the tax credit caused an increase in R&D expenditures. In addition, the R&D tax credit appears to have contributed to increased competitive R&D spending among the firms in the pharmaceutical industry.