The UK’s Tax credit is failing despite being much larger than the US’. Expansion is not the answer.

The UK government’s £7.3bn research and development tax credit system is failing to deliver significant additional spending by businesses, according to a report that warns the 20-year-old policy could prove a “costly failure”. Aggregate business expenditure on R&D in the UK, as a percentage of national income and net of tax credits, is estimated to be between 10 and 15 per cent lower than before R&D tax credits were introduced, according to the Centre for Business Research at Cambridge Judge Business School. The report said the government would struggle to meet its target for R&D spending to reach 2.4 per cent of gross domestic product by 2027 as a result. The R&D tax credit scheme, which either reduces corporation tax or generates a cash credit, has grown steadily since its introduction in 2000 and is now used by 60,000 companies a year.

But the report, published on Tuesday, pointed to Office for National Statistics data that show the impact of the tax credits on business investment in R&D has been “insignificant”. “The theory behind R&D tax credits, namely that a reduction in the cost of R&D will lead to an additional increase in a company’s R&D expenditure, is flawed,” it said. The report also questioned government claims that each £1 of R&D tax credits generates between £1.40 and £1.70 of additional R&D spending. “The Treasury’s R&D tax credit scheme has, by accident or oversight, become the government’s flagship industrial policy,” said the report’s author, David Connell, senior research associate at the Centre for Business Research. “But without the scheme stimulating significant additional business spending, it cannot bridge the huge gap between current levels of business R&D expenditure and the level required to deliver on the government’s overall target.” A further £500m of tax credit payments subsidises R&D undertaken outside the UK, according to the report.

The research comes as the Treasury has started a consultation on modernising the R&D tax relief schemes, which will consider all elements to ensure that reliefs “continue to be fit for purpose and deliver good value for money for the taxpayer”. The UK’s most recent estimate put overall R&D spending at 1.7 per cent of GDP in 2018, combining public sector with private spending, up only marginally from 1.6 per cent in 2000 and below the OECD average of 2.4 per cent. The report also argues that the Treasury’s £1.1bn-a-year Patent Box scheme, a lower rate of corporation tax to encourage commercialising intellectual property, has failed to deliver its objectives given profitable multinationals and other large companies have taken the vast majority of the benefits.