Taxation and innovation: evidence from Colombia

ABSTRACT

We use firm-level data from a Colombian manufacturing survey, complemented with data from the tax department, to test the effect of firms’ total tax and contribution rate (TCR) on the ratio of innovation expenditures to sales. We construct a data panel from 2003 to 2018 comprising 104,762 observations and implement fixed effects and instrumental variables estimation methods. Our results suggest that an increase of one percentage point in direct taxation leads to a decrease of 0.10% in the probability that firms engage in innovation investments, and market power moderates this effect. We discuss distinctive features of the effect of taxation on innovation in emerging economies—one being the inability of local innovation clusters to temper it. Policy implications include considering modifications to the magnitude and composition of the TCR as an alternative to R&D tax credits.

KEYWORDS:

• Instrumental variables
• panel data
• tax incidence
• market structure
• business innovation

JEL CODES:

• C26
• C33
• H22
• L10
• O31

Acknowledgments

The authors would like to thank Fernando Vargas, Gustavo Crespi, Pierre Mohnen, Philip Shapira, Danny Hughes, and Ligia Melo for valuable discussions. The views expressed here are those of the authors, who are responsible for any errors or omissions

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 E.g., Hall and Jorgenson (1967), Summers (1981), Grubert and Slemrod (1998), Gruber and Saez (2002), and Devereux, Liu, and Loretz (2014).

2 E.g., Lokshin and Mohnen (2013), Montmartin and Herrera (2015), Crespi et al. (2016), Chang (2018), Appelt, Galindo-Rueda, and Cabral (2019), and Labeaga et al. (2021), (Bloom, Van Reenen, and Williams 2019).

3 With the exception of two studies of Chinese firms discussed below. It must be noted however that in many aspects the Chinese case differs greatly from that of the rest of developing countries.

4 Inclusion parameters are having over 10 workers and 180,000 USD of production value (at 2016 prices).

5 The World Bank’s Total Tax and Contribution Rate measures ‘the amount of taxes and mandatory contributions payable by businesses after accounting for allowable deductions and exemptions as a share of commercial profits. Taxes withheld (such as personal income tax) or collected and remitted to tax authorities (such as value added taxes, sales taxes or goods and service taxes) are excluded.'

6 Other estimates disagree with the World Bank figure and find a lower rate after applying all the discounts and the effect of avoidance and evasion. However, they all agree on overall high corporate tax burden (see Olivera (1996), Cardenas and Mercer (2005), Avila and Leon (2008), ANDI (2014), Gomez and Steiner (2015), Avila-Mahecha (2015)).

Additional information

Funding

A previous version of this research was funded by the Inter-American Development Bank (IDB).