Innovation on Hold: When Tax Incentives Crowd Out SME R&D
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Tax incentives are meant to buy more innovation from small and medium-sized firms. New HAPRI research on Vietnamese SMEs finds the opposite: receiving a tax incentive substitutes for firms' own R&D spending by roughly 3 percent — a crowding-out effect rather than a boost.
Context
Tax incentives have become one of the most widely used public policy instruments for pushing firms toward innovation, and interest in them has grown among both researchers and governments in recent years. The logic is straightforward — lower the after-tax cost of research, and firms should do more of it.
That logic rests on an assumption worth testing: that public support adds to private research effort rather than replacing it. Whether government support complements or substitutes for a firm's own R&D intensity is an empirical question, and for smaller firms in an emerging economy the answer carries real budgetary weight.
Methods
The study uses firm-level panel data on Vietnamese SMEs and applies an instrumental variables strategy, which helps separate the effect of the incentive itself from the characteristics that make a firm likely to receive one in the first place. The analysis asks two linked questions: what tax incentives do to technological innovation performance, and whether they complement or substitute for R&D intensity.
Key findings
Receiving a tax incentive substitutes for SMEs' own R&D intensity by approximately 3 percent — evidence of crowding out, not crowding in.
The pattern scales with the size of the benefit: firms receiving larger tax incentives invest less in R&D than firms receiving none, a "sand-the-wheel" rather than "grease-the-wheel" effect.
The authors theorize a political-economy channel: collusive relationships between firms and political entities reward the expansion of political networks over investment in uncertain, high-risk research projects.
The policy implication points less at the incentives themselves than at how they are administered — toward greater transparency and accountability in the tax system.
Keywords:
Tax Incentives
R&D Crowding Out
SMEs
Innovation Policy
Vietnam
Instrumental Variables
Link:
Citation:
Hoang Nguyen Quoc Thanh, Nguyen Quynh Huy (2026). Innovation on hold: Tax incentives and R&D crowding-out effects among SMEs in Vietnam. Journal of the International Council for Small Business, 1-16.
