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R&D an election issue?

7 April 2017

Regular readers will know my feelings on things like grants and subsidies to companies which engage in research and development activities.

For those who are new here, let me recap...

The current system of "grants" is insanity at its worst.

Actually *giving* taxpayers' money to (usually) large companies to help offset their R&D costs is utterly ridiculous and actually suppresses the bold, innovative, new startups that are really the cornerstone of a vibrant economy.

Over many years I've watched as successive governments in NZ have effectively given away hundreds of millions of taxpayer dollars to companies (like F&P) that can well afford to fund their own R&D activities -- while some of the brightest startups with the most valuable ideas are forced to flee the country to raise their R&D capital.

Such systems are simply a redistribution of wealth from the poor to the rich. F&P doesn't need a few million here and there -- they're already doing "very nicely thank you" but, because of the way these grants are structured, it's often only the big companies who can afford to apply for them and uplift them. The bureaucratic overhead involved and the qualifying criteria usually leave the small guys out in the cold -- regardless of the merits of their ideas and products.

What we need is an egalitarian R&D funding solution that applies to everyone, equally and the only way to really do that is by way of tax.

Interestingly enough, there's talk that this may be an issue in the election to be held later this year.

Some of the most successful R&D subsidy systems operate solely on a tax-credit basis and this is the way I'd like to see NZ go.

Giving money away in the form of grants is utter folly, as we've seen in the past where at least one company's shareholders pocketed millions in taxpayers' money just before selling out to an offshore purchaser. Where was the value to the NZ taxpayer in that arrangement?

Let me repeat what I propose...

Only new startups would qualify for this -- which means companies that have been trading for less than 4 years.

They would be entitled to a tax-credit equal to 150% of the money they spend on R&D activities. This credit would be non-transferable and could not be converted into cash.

Let's see how this works from a "cost to the taxpayer" perspective, in the case of a successful startup and an unsuccessful one:

We will assume that our startup spends $2m on R&D over two years. This earns them a tax credit of $3m against future earnings.

Given that very few startups actually make a profit during their R&D period, the taxpayer has forgone no tax revenue so the cost to taxpayers in this period is a big fat zero (unlike a grant which would have had to be taken from the pockets of Kiwis).

Let's say that this startup is unsuccessful and folds after those first two years. The $3m in tax credit effectively vanishes at that time -- since it can't be transferred to another entity or cashed out. Once again, the cost to taxpayers is a big fat zero -- unlike the situation with a grant whereby the taxpayer would still be out of pocket to the tune of the grant money given to the company.

Now let's say that instead of failing, the company becomes a great success.

In years 3 and 4, the company might earn $10m in profit and be liable for $2m in tax.

Now, because it has a $3m tax credit, no tax is paid on that profit -- which delivers an excellent return for investors (more on the importance of this later). Yes, it could be argued that the taxpayer has now missed out on $2m in tax revenue but it should be remembered that such a company will have been employing people (who pay PAYE and GST and put their wages into the economy) so the true scale of the lost tax is far less than one might think and perhaps less than the value of grants currently handed out under the existing system. Also, we now have another thriving business which almost certainly contributes to our export earnings and, from year 5 onwards, it will be paying tax at the normal rate.

So as you can see... this is generally a no-risk option for taxpayers. Unlike the situation with grants (where actual money is handed over from taxpayers' pockets), the tax-credit system costs us nothing when startups fail and, as we know, a great many of them will.

Yes, we forgo a little tax revenue in the case of the successful ones but we claw that back by way of PAYE, GST and future tax revenues.

Now the real value of this proposed system is that it makes it *much* easier for startups to get funding from the private sector -- which is where all startup funding should come from. For government to provide startup funding as they do now through the grants scheme is a case of trying to pick winners and as we all know, governments are notoriously bad at that.

Private investors will love investing in startups under this scheme because they know that profits earned in the first 4 years will have the benefit of that 150% tax credit earned by their investment. This means that the return on their investment is far greater than it would otherwise be.

So what's wrong with my plan?

Why would it not make sense to switch from grants to a "no risk" system such as the tax-credit scheme I've proposed?

Surely it's not a good idea to simply hand out huge fists-full of cash to lame startups (like the Martin Jetpack for instance) which sound great but have no commercial viability?

Do we need to lobby the contenders in the next election to start thinking smarter about the handling of R&D activities in this country -- because our spend is pretty sad compared to the rest of the developed world and as we can see, dairy is already stretching the nation's environment to breaking point so we need to diversify.

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