Wednesday, July 6, 2011

One solution: How to increase New Zealand's R&D spending and stop educated people from leaving the country

I've engaged in an interesting debate with TUANZ Chief Executive, Paul Brislen (@paulbrislen) on Twitter. Paul asked this country's politicians:

"NZ has some of the lowest R&D spend in the OECD. What will you do to fix that?"

My response to Paul is that I don't believe that the statistics are accurate. New Zealand companies don't have an incentive to account for R&D. In fact there is a big disincentive to account for it. If you hired someone or purchased something and your intention is R&D, that means that it is a capital expense. Capital expenditure is not immediately tax deductible. You have to capitalize and depreciate it. This means that not only you are out of pocket for investing into something that doesn't bring you any immediate return, but you also can't claim it as tax deductible expense. I believe that the way New Zealand businesses structured is to ensure that their efforts are considered operational expenses and not R&D. This is why the statistic Paul refers to is inaccurate and meaningless.

To this, Paul responded:

"not according to the OECD and that means investors looking for new stuff pass us by." "... if you're looking around the world for centres of innovation what do you look for? R&D spend. If we hide ours..."

I don't believe it works like that with investors. I believe investors are looking for returns on their investment, not centres of innovation. Technology investors, in particular, are looking for two things: (a) Availability of talented people to perform the R&D and (b) Markets to sell the resulting products. In New Zealand we are short on both.

Paul's latest comment was:

"I'm talking about the angel investor funds and the like. If all it takes to get on the radar is an accounting change, why not?"

That comment has prompted me to write this blog, as I don't think 140 characters is enough for this important subject. It is not as simple as an accounting change, as I described earlier, as people will loose real money. However, even if it wasn't for that, some government statistic is still not enough incentive for businesses to change their accounting practices.

Last government's answer to the problem was to introduce tax rebates for R&D. That policy was a complete failure and didn't achieve the desired result. The definition of R&D was too narrow and didn't cover any real commercial R&D. However, being a "tax credit" - translation, "cash handout", if you made the definition any broader, anyone and everyone who's business relates in any way to any technology will be asking government for cash. I applaude the current government for dumping that tax credit scheme.

The problem of trying to drive R&D through other company tax incentives is that by its nature, R&D doesn't produce any immediate income, therefore there is no tax to pay. So what can you do?

I believe I have an answer to this problem. Here are a simple two step solution:

Step 1. Make all R&D related expenses 100% tax deductible, same as operating expenses.

This step will remove the accounting disincentive. However, in itself it is not enough.

Step 2. Redice the income tax burden for all employees that are engaged in Research & Development activities. Make it so the higher the qualification, the lower the tax burden.

This will achieve many goals desired by the people of New Zealand:

  1. It will be more attractive for people with higher education that can be applied to R&D (scientists, engineers, programmers etc...) to stay in New Zealand - they've just got a pay raise!
  2. In fact, educated people from overseas will want to come and work here so they can earn more
  3. It will be more attractive for investors to set up shop in New Zealand - they will have happier staff earning more money without themselves having to shell out extra.
  4. It will be more attractive for business people to account for R&D appropriately - their staff will earn more so will be happier to stay
  5. It will be more attractive for young people to pay for higher education - your student loan is no longer such a burden, it will be paid for by the tax break
  6. You will have young people more interested in science and engineering than arts and law
  7. You will have larger pool of talent so international technology investors will be interested in coming here to set up shop.

And this policy is not too expensive to implement. According to that OECD report there isn't much R&D accounted for in New Zealand, so there will be minimal revenue loss to the government. They will pay in tax breaks to the researchers, however that will be made up by other activity of the companies doing R&D. Also, the ratio of research to other staff in those companies is pretty small.

It will also be a very minor cost to businesses - we already have a system of PAYE tax codes, so all that needs to be implemented here is a new code.

So, would any political party like to adopt this policy? You'll have my vote!

And, to top it all, this policy is really easy to sell to New Zealand public. At the end of the day you are not giving any money to someone as extra profit. You are leaving more money for the worker - the researcher and the engineer.