The response of the pharmaceutical industry to the research and experimentation tax credit provision of the Economic Recovery Tax Act of 1981

The Economic Recovery and Tax Act of 1981 provided for a 25% tax credit for increases in research and experimentation expenditures for all firms. The objective of this tax credit was to encourage companies to make additional expenditures in research and development. Although the tax credit expired in 1985, the Tax Reform Act of 1986 extends it for an additional three years at the 20% level.;Given this objective of public policy, this thesis examines how the pharmaceutical industry responded to the R&D tax credit. As part of this analysis, the study uses concepts from contemporary management literature to look within the industry and to analyze the behavior of the strategic groups in the pharmaceutical industry with respect to the R&D tax credit.;The industry was divided into four clusters of firms. Regression analysis was used to estimate the change in research intensity (research/sales) caused by five explanatory variables. The R&D tax credit was found to be positive and significant in each cluster. Research intensity was inversely related to the number of research activities. Relative cash flow had a positive effect on research intensity in two clusters, but it had a negative effect on research intensity in one cluster. High percentages of pharmaceutical sales caused higher research intensities in three clusters, while causing lower intensity in one. Success with new products caused increased research intensities in two clusters, while causing decreases in one. While it appears that there were different levels of response to the tax credit by the clusters, limitations with the data set precluded conclusive findings.;The study found that the tax credit caused a substantial increase in the research intensities of the clusters of firms in the pharmaceutical industry. Thus, in this industry, the use of the R&D tax credit has achieved the government's objectives of increasing the level of resources devoted to R&D.