If there’s one thing that most governments can agree on, it’s that innovation is a good thing. As a result, the last twenty years have seen an expansion of research and development (R&D) tax incentives that encourage businesses to invest in innovation. But not all innovation is equal. With climate change an acute concern worldwide, is it time governments reconsider subsidies for R&D that makes fossil fuels cheaper and easier to extract?
Governments around the world try to encourage businesses to invest more in R&D, because innovation is the long-term engine of rising prosperity. But businesses often need encouragement to invest in R&D, because successful innovations can be copied by competitors. While the patenting system helps reduce this risk, unless government provides a helping hand, fewer businesses would be willing to risk their investments on R&D projects, slowing the overall rate of productivity growth across the economy.
Tax credits are a particularly appealing way for governments to support innovation. They are available to all firms and sectors across the economy and it’s up to businesses to decide where technological progress can be most fruitful. In contrast, a system based on government grants requires a government agency to make decisions about which projects should go ahead. Many observers—particularly those sceptical of ‘big government’, argue that governments lack the technological or market knowledge to make good decisions and should let businesses decide.
But as we face the mounting horror of the climate crisis, it’s not just the amount of innovation and growth that matter. It’s the direction. Global assessments have repeatedly shown that an efficient transition to a zero-emission world is urgent but impossible without innovation in clean energy technologies. Clean energy technologies are becoming cheaper, but investment in fossil fuel innovation means that they’re chasing a moving target. Governments need to play a role in shaping the direction of innovation, not just encouraging more of it.
Australia’s astonishing generosity
R&D tax credits treat all areas of technology and all sectors equally, and this means that they direct taxpayer money towards innovation that risks slowing the energy transition: innovation in fossil fuel extraction. This is true globally, but Australia’s generosity to fossil fuel extraction is particularly startling. In the years for which data is available (2012-2018), Australians gave fossil fuel extraction companies more than A$1.4 billion in support for R&D through the tax system. Because Australia’s R&D tax incentive system allows companies to carry forward R&D credits, the ultimate figure will be much larger: as of 2018, fossil fuel extraction companies were holding onto A$880 million in carried forward credits.
In a recent paper, I compared the scale of R&D tax credits provided to fossil fuel extraction companies in Australia, Canada, Norway and the UK. All four have substantial domestic fossil fuel extraction activities, and all make use of R&D tax credits to foster innovation. The most recent data available (which is for 2015) enables a comparison of the four countries. The data—gathered from national tax offices—show that on a per-capita basis Australia’s system was five times more generous to fossil fuel extraction firms than the system in the UK or Canada, and ten times more generous than Norway.
Part of the explanation for the difference between countries is hidden in the detailed design of tax incentive policies. In Norway, individual taxpayers cannot claim R&D tax relief on expenditures above around A$4 million. In contrast, the Australian ‘ceiling’ on eligible expenditure is A$150 million (and prior to 2015 there was no cap). Since fossil fuel extraction is often dominated by very large firms, limits on the maximum that can be claimed by any one company is likely to drive big differences in the overall generosity of the incentive to fossil fuel extraction.
It would be nice if this money was being used by fossil fuel companies to future-proof Australia’s economy, by investing in carbon capture, for example, or by diversifying into cleaner energy technologies like hydrogen and renewables. Unfortunately, the evidence suggests that—at least up until 2019—this was not happening. My research shows that patents filed by Australian companies whose principal activities are fossil fuel extraction have largely been focused on innovations that facilitate the extraction of coal, oil and gas.
It’s time to adapt Australia’s R&D tax incentive so that R&D projects whose purpose is the extraction of coal, oil and gas are not eligible. Although R&D tax credits are typically sector- and technology-neutral, there are plenty of places that have offered higher rates of R&D tax support for strategically important areas. Wisconsin offers higher rates for R&D on internal combustion engines, for example, while the United Kingdom for many years offered higher rates for research on vaccines. These examples show that there are no insurmountable administrative obstacles to an R&D tax regime that treats particular areas of science and technology differently.
At a time when the world is ramping up action to reduce greenhouse gas emissions, and when it is becoming increasingly clear that most of the world’s fossil fuel reserves should stay underground, tax support for companies to develop new ways of extracting fossil fuels is a poor use of public money. Let’s save the Australian taxpayer hundreds of millions and cancel R&D tax credits for fossil fuel extraction.