Unlike many developed countries, Germany’s tax system does not directly reward business investment in research and development. But that could be about to change.

Germany is a leader in R&D investment.

Pressure is growing on Germany’s finance ministry to introduce tax breaks to support businesses which make significant investments in research and development.

Berlin has long promised reform in this area, only to recant later. However, this was included in this year’s coalition agreement between Angela Merkel’s center-right Christian Democrats (CDU) and the center-left Social Democrats (SPD). But a lack of progress since has alarmed the country’s business community, which fears the issue has again slipped down the government’s domestic agenda, currently dominated by pension and labor market reform.

Germany is one of just seven out of 34 countries in the Organization for Economic Cooperation and Development which do not offer tax breaks to businesses investing in research and development. In neighboring Austria, the government offers 14 percent cashback on research expenses. France offers a generous 50 percent first-year tax incentive to innovative firms setting up in the country.

Proponents of tax breaks say action is needed to achieve the government’s target of raising national R&D spending to 3.5 percent of GDP. Germany is already no slouch in this area. In 2016, it invested 2.93 percent of GDP in R&D, more than the United States and the European Union average. But hitting the 3.5 percent benchmark will probably require new measures.

20 p11 R&D investments on the rise-01

The apparent delay in implementing tax breaks has set off alarm bells because the previous CDU-SPD coalition made very similar promises in recent years, but later backed off saying it was too expensive and inefficient. Skeptics fear that tax breaks would simply give rise to windfall effects, with companies transferring the costs of existing research onto taxpayers, instead of funding new research.

But Handelsblatt has learned that a draft law is due to be put forward after the summer recess. Finance ministry sources even suggest that, although Berlin has earmarked no specific money for R&D tax measures in the 2019 federal budget, Minister Olaf Scholz is prepared to make funds available. Support may include R&D spending by large corporations as well as small-to-medium sized businesses. But any law would first have to pass both houses of the German parliament.

A more 'neutral' way to support R&D

One way or another, Germany pumps a lot of public money into research and development. In 2017, the federal government spent €17.1 billion, with €7.4 billion going directly to specific projects. Mr. Scholz has already announced an additional €3.4 billion over the next four years.

Supporters of tax reform say the state is not always the best judge of projects, and tax breaks offer a “neutral” way of supporting best practice in innovation. A study from the government’s Expert Commission on Research and Innovation (EFI) suggests that every euro of tax subsidy generates an additional €1.33 in R&D funding.

Anja Karliczek, the federal minister for research, is a supporter of tax breaks. She insists new funding must be found for any measures, rather than taking a chunk out of the existing budget. She also proposes to extend tax breaks to external research contracts, allowing companies without inhouse research to benefit.

The coalition deal refers to “small and medium-sized businesses,” but ministers like Ms. Karliczek are pushing to include larger corporations in any new legislation. That could also be popular with the trade unions, which are well-represented in large companies. This in turn may win over the SPD, which historically has close ties to unions.

Frank Specht is based at Handelsblatt's Berlin bureau, where he focuses on the German labor market and trade unions. Jan Hildebrand leads Handelsblatt's financial policy coverage and is deputy managing editor of Handelsblatt's Berlin office. Dana Heide is a political correspondent for Handelsblatt. To contact the authors: [email protected], [email protected], [email protected].