Measuring Firm-Level Productivity Convergence in the UK: The Role of Taxation and R&D Investment

Abstract

This paper examines the direct effects of corporate tax on firm productivity along with the interaction effects of tax policy and R&D activity on productivity at firm level for over 13,062 firms during 2004-2011. Our main findings are first, that there is evidence for productivity convergence and we find that there is a positive robust relationship between R&D and firm productivity, whereas tax policy has a negative distortionary effect on TFP. Second, firms with greater export orientation do not seem to achieve much improvement in productivity, whereas the favourable productivity effect in the case of R&D-based firms suggests that if there are tax incentives in place for R&D type activity, it can promote innovation and drive productivity convergence (lagging firms closing the technology gap with those at the frontier), particularly so when there is a continued decline in overall economic activity. The results also show a significant non-linear effect of tax rate on firm-level productivity, identifying an inverse U-shaped relationship. Keywords Non-technical summary and policy implicationsThis paper argues that technological innovation is vital to enhancing firm-level productivity or efficiency growth, and thus investment in R&D can play a larger role in determining the differences in productivity across firms and help achieve productivity convergence. During periods of general economic slowdown, corporate tax policy may drive such innovation and therefore the paper examines the direct effects of corporate tax on firm productivity along with the interaction effects of tax policy and R&D activity on productivity at firm level for over 13,062 firms during 2004-2011. Our main findings are first, that there is evidence for productivity convergence and we find that there is a positive robust relationship between R&D and firm productivity, whereas tax policy has a negative distortionary effect on TFP. Second, firms with greater export orientation do not seem to achieve much improvement in productivity, whereas the favourable productivity effect in the case of R&D-based firms suggests that if there are tax incentives in place for R&D type activity, it can promote innovation and drive productivity convergence (lagging firms closing the technology gap with those at the frontier), particularly so when there is a continued decline in overall economic activity. The results also show a significant nonlinear effect of tax rate on firm-level productivity, identifying an inverse U-shaped relationship with a threshold level of around 45% as the optimum productivity-enhancing effective tax rate.

Study on the Impact of Tax Reduction Policies on Total Factor Productivity of Manufacturing Industry in Sichuan Province under High-Quality Development

“…It has also been argued that tax cuts have little effect on total factor productivity and may have a dampening effect. Mallick et al (2013) argue that there is a significant and non-linear effect of tax rates on productivity levels [7]. Sally Yang (2019) confirms the "inverted U-shaped" relationship between tax incentives and the investment, production and innovation of manufacturing firms, further suggesting that tax incentives do not always have a positive effect on firms' total factor productivity improvement [8].…”

Allocation of human capital and innovation at the frontier: firm-level evidence on Germany and the Netherlands

“…In addition to the studies mentioned above, existing studies using the second method include Coad and Rao (2006) on the impact of R&D expenditures and patents on a firm's market value at different points of the conditional Tobin's q distribution and Ho ¨lzl and Friesenbichler (2010) on the differential impact of R&D and innovation for high-growth firms in countries close to the technological frontier using firm data from the third Community Innovation Survey in 16 countries. Existing studies using the third method include Griffith et al (2003a) on the role of foreign presence in raising the speed of convergence to the technological frontier using a panel of British establishments, Nishimura et al (2005) on the speed of convergence-taking explicitly into account possible biases caused by exits-in IT and non-IT industries using a panel of Japanese firms, Sabirianova Peter et al (2012) on whether more efficient firms have a higher probability than less efficient firms of moving up in the overall distribution of productive efficiency in any given year and on factors affecting the evolution of the efficiency gap using a panel of firms in the Czech Republic and Russia, and Bournakis et al (2013) on the role of investment in R&D in achieving productivity convergence using a panel of British firms. Combining the first and second method, we evaluate how the impact of human capital and innovation vary at different points of the conditional productivity distribution while controlling for a firm's distance to the industry frontier.…”

Productivity effects of corporate income tax: Evidence from China

“…Hungary lowered the CIT rate to 9% in 2016, Italy reduced its CIT rate by 3.5% in 2019 and the US passed the ‘Tax Cuts and Employment Stimulation Act’ in 2017, reducing the CIT rate from 35% to 21% and triggering a wave of global tax cuts (Hannon, 2017). Research on developed countries such as the United States of America (USA) and the United Kingdom (UK) and the Organisation for Economic Co‐operation and Development (OECD) countries (or developing countries, such as China and India), generally find that taxation can effectively affect TFP (Arnold et al, 2011; Bournakis et al, 2013; Chaurey, 2017; Chen, 2013; Everaert et al, 2015; Heier & Ljungqvist, 2015; Li & Zhang, 2015; Liu & Mao, 2019; Peng & Mao, 2018). Still, the impact of the CIT rate changes on corporate TFP remains unclear.…”

“…First, it enriches the research on CIT and TFP from the perspective of China. The current literature specifically addressing the productivity effect of CIT is somewhat limited (Liu & Mao, 2019), as researchers have primarily studied the impact of CIT on TFP from the perspective of OECD, USA, UK and other developed countries (Arnold et al, 2011; Bournakis et al, 2013; Gemmel et al, 2010; Hussain, 2015; Schwellnus & Arnold, 2008). Since developed and developing countries differ in many aspects, such as the market environment, these conclusions about CIT and TFP cannot apply directly to developing countries like China.…”

“…Third, this paper uses DID analysis to solve the empirical endogenous and misspecification problems. Approaches like ordinary least squares (OLS) and vector autoregressive (VAR), used by Bournakis et al (2013) and Hussain (2015), cannot solve potential exogenous problems that may arise from omitted variable bias and reverse causality. On the one hand, companies with higher TFP have richer tax planning resources and experience, which can affect corporate tax (Liu & Lu, 2015).…”