Tax incentives ... or subsidies for business R&D?

We study whether firms' actual use of R&D subsidies and tax incentives is correlated with financing constraints -internal and external- and appropriability difficulties and investigate whether both tools are substitutes. We compare the use of both policies by SMEs and by large firms and find significant differences both across instruments and across firm size. For SMEs, financing constraints are negatively correlated with the use of tax of credits, while they are positively associated with the likelihood of receiving a subsidy. The use of legal methods to protect intellectual property is positively correlated with the probability of using tax incentives, but not with the use of subsidies. For large firms external financing constraints are correlated with instrument use, but results regarding appropriability are ambiguous. Our findings suggest that (1) direct funding and tax credits are not perfect substitutes in terms of their ability to reach firms experiencing barriers associated to market failures; (2) one size may not fit all in innovation policy when the type or intensity of market failure differs across firm size, and (3) subsidies may be better suited than tax credits to encourage firms, especially young knowledge-based firms, to start doing R&D.