Discriminatory R&D policy mix for small and large firms: Policy sequencing and behavioral responses

Abstract

This paper examines the interaction between the allocation of R&D subsidies and tax incentives, and how policy sequencing shapes the behavioral outcomes of the policy mix, particularly for small and large firms. We analyze a Chinese R&D tax incentive program that provides tax incentives to firms with R&D intensity above a specified threshold. We document discriminatory policy sequencing: large firms typically receive larger subsidies before qualifying for tax incentives, whereas small firms receive larger subsidies after becoming eligible for tax incentives. This sequencing is associated with heterogeneous behavioral responses. Large firms tend to maintain their R&D levels just above the threshold, whereas small firms continue to increase R&D spending after surpassing the eligibility threshold and receiving tax incentives. The empirical findings indicate a policy misalignment: financially constrained small firms rely more on subsidies to cover upfront R&D costs, whereas large firms strategically respond to the tax incentive threshold even without initial R&D subsidies. Our study highlights the importance of aligning policy-instrument sequencing with firms' specific needs and conditions to design and implement more effective R&D policy mixes.