John W. Diamond, “The Economic Effects of Research and Development Tax Incentives in Texas,” Rice University’s Baker Institute for Public Policy, November 8, 2024, https://doi.org/10.25613/ZC1W-K552.
Research and development (R&D) activities of private businesses, universities and the government are important for increasing innovation. Sustained increases in economic growth and the standard of living will be primarily driven by technological innovation in the near future, making it imperative that Texas act to increase R&D investments. One way to do this is by reforming, extending and increasing the R&D tax credit.
Texas has underperformed in generating R&D expenditures in relation to other economic characteristics of the state. The major reason for the lack of R&D expenditures is directly related to inefficient and ineffective tax policy in regard to innovation for a substantial part of the last two decades. During this period, Texas enacted incentives into law from 2000 to 2007 and from 2014 to 2026 but the magnitude, structure, and temporary nature of the incentives are all potential reasons for the underperformance in R&D expenditures relative to other states.
In 2023, Texas ranked second in population at 9.1 percent of the total US population and second in gross state product (GSP) at $2.6 trillion or 9.3 percent of the national output. As of 2022, the latest data available, Texas ranked 5th in business-funded R&D expenditures at 4.3 percent of the total $608 billion funded by businesses in the US. California (36.2 percent), Washington (9.2 percent), Massachusetts (7.1 percent) and New York (4.9 percent) all rank ahead of Texas in terms of the share of total business-funded R&D expenditures. Texas ranks 33rd in terms of R&D expenditures as a percentage of GSP, with a ratio of 1.78, confirming that relative to the size of the Texas economy, R&D expenditures are below average.
The R&D tax credit examined in this paper is roughly equivalent in magnitude to the current R&D incentives in Texas that have been in effect from 2014 to the present. The current incentives are small compared to incentives in other states after accounting for differences in GSP. The simulations in this paper demonstrate that enacting an R&D tax credit will increase the size of the Texas economy by more than enough to offset the cost of the policy. The implication is clear. The question is not whether Texas can afford to extend the R&D tax credit, but instead is whether Texas can afford not to extend the R&D tax credit. A larger incentive would of course yield a larger return and make Texas more competitive with other states for R&D projects. Extending the R&D tax credit at its current level is a first step, and it will definitely have a positive impact on the Texas economy, but a significant increase above the current level, whether now or in the future, is necessary if Texas wants to lead the nation in innovation and growth.
This paper is a work in progress and has not been through editorial review. View the full working paper (PDF).
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