The long-running debate over whether R&D Tax Credits deliver value for money has re-emerged in Parliament.
Dr David Connell, whose 2021 Cambridge Judge report was instrumental in convincing the Treasury to significantly downgrade R&D Tax Credits for SMEs, returned to give evidence to the House of Lords Science and Technology Committee.
Once again, his core message was that the R&D Tax Credit regime delivers weak “additionality” and that much of the £7.6 billion annual cost should be redirected into more targeted programmes.
Whilst it was a more measured version of the argument he put forward four years ago, the underlying message was that the UK’s R&D scheme is still expensive, poorly targeted and less effective than ministers claim.
The importance of Connell’s 2021 report to today’s R&D Tax Credit landscape is hard to overstate.
His critique came at a moment when the Treasury was already concerned about the cost and management of the R&D scheme.
The report fed directly into the policy debate that produced the 2022 cuts. Those changes fundamentally changed the system and contributed to SME claim volumes dropping by around half within two years.
The worry is that old arguments are starting to re-surface just as the system is finding some long-awaited stability. If government falls back on the same lines of thinking that influenced the 2021 debate, there is risk of sliding into another round of decisions based on a picture of business R&D that is incorrect.
To understand why Connell’s reappearance matters, it is necessary to revisit what happened last time.
The 2021 “costly failure” report
In May 2021, the Cambridge Judge Business School released a report (“Is the UK’s flagship industrial policy a costly failure?”) that was poured over in the Treasury.
Written by David Connell, it argued that the UK’s R&D Tax Credit scheme had failed to increase business R&D spending and described the SME element as a “costly failure”.
Its headline claim, based on Office for National Statistics (ONS) data, was that business R&D spending as a share of GDP had hardly moved in two decades, despite billions of pounds in tax relief.
If correct, it suggested the R&D scheme delivered little additionality, carried substantial economic “deadweight” and was in need of major reform.
The report was released at a moment when the Treasury was already nervous about the growing cost of the R&D scheme and unconvinced about its impact. Within months, Connell’s analysis, bolstered by a foreword from former Business Secretary Greg Clark, had become a key reference point in how ministers and officials talked about R&D Tax Credits.
The connection between the Cambridge Judge report and subsequent policy became obvious eight months later in the then Chancellor Rishi Sunak’s Mais Lecture in February 2022.
In a section on innovation, Sunak outlined what he saw as the UK’s central weakness: that business R&D investment had stagnated while other OECD countries had pulled away. He quoted directly from Connell’s published analysis, saying:
“Self-financed [UK] business R&D as a % of GDP is less than half the OECD average. And as Cambridge economist Dr David Connell’s research shows, whilst other nations’ businesses have increased the share of GDP they devote to R&D investment by 50% in recent decades, UK business investment in R&D has stayed flat or even fallen.”
Sunak then turned to what he considered the imbalance between the cost of the R&D Tax Credit regime and the level of business R&D it was generating:
“So what should we do to support greater private sector investment in R&D? One obvious answer is to look at our tax regime… On the face of it, we have one of the most generous tax regimes for R&D anywhere in the world… But in spite of spending huge and rapidly growing sums, clearly it is not working as well as it should. In the UK, business spending on R&D amounts to just four times the value of R&D tax relief. The OECD average? 15 times.”
Taken together, Sunak’s remarks sounded like a wholesale endorsement of Connell’s argument and a warning that the SME scheme would face cuts.
The difficulty came only months later, when the ONS published a major revision to its BERD (Business Enterprise Research and Development) statistics which overturned the data that Connell, and by extension Sunak, had relied.
The ONS correction
In September 2022, the ONS announced that small-business R&D had been significantly underestimated for years. Its adjustment was substantial. Business R&D was revised upwards by £15.0 billion for 2018, £15.6 billion for 2019 and £16.1 billion for 2020.
These changes lifted the estimated R&D intensity of the private sector and showed that the long-standing target of 2.4% of GDP being invested in R&D had been met several years earlier than expected.
Far from stagnating, business R&D had been rising much more strongly than the published figures suggested. The apparent flatlining that underpinned the “costly failure” thesis had relied on data that was later corrected.
By the time this became clear however, Treasury policy was almost certainly decided.
Were R&D Tax Credit cuts based on flawed evidence?
When the ONS published its revised business R&D estimates in September 2022, the policy debate had already been heavily influenced by the Cambridge Judge report. The ONS correction should have prompted a pause for reassessment. Instead, just two months later, the Autumn Statement delivered a sharp reduction in the SME payable credit, the first time the benefit had ever been cut.
In his House of Commons speech, the Chancellor Jeremy Hunt justified the cuts largely on the grounds of fraud and error.
It was widely agreed that R&D Tax Credit compliance needed strengthening but as I wrote at the time (in my article “Tackle R&D Tax Credit fraud instead of punishing blameless SMEs”), combatting fraud shouldn’t require reducing the value of the incentive.
Once the ONS corrected the BERD figures, the assumptions about weak SME additionality and low value for money should have been revisited as the new data didn’t support the previous assumptions.
As we now know, the data was never reassessed and the 2022 Autumn Statement cuts went ahead on the basis of arguments put forward before the statistics were revised.
The “costly failure” label had proved persistent, despite the revised data.
Connell’s return
Four years on, the argument has resurfaced. Earlier this year, David Connell appeared before the House of Lords Science and Technology Committee to set out his latest views on the R&D scheme.
Connell’s central position has not altered markedly from 2021. He told peers that the UK channels too much money into R&D Tax Credits and that a significant share of the £7.6 billion annual cost should be redirected into grant-based or procurement-led programmes.
He argued that R&D Tax Credits do little to influence business behaviour, that early-stage founders benefit little from them and that more targeted programmes would produce a greater long-term economic return.
Connell told the Lords’ Committee that “[R&D Tax Credits] do not help entrepreneurs start unless they raise venture capital.”
He even argued that, for companies such as ARM, Dyson, Sage and Autonomy, “R&D Tax Credits would have had little or no value to them in the start-up phase”.
It is interesting that, given how strongly his 2021 analysis informed the debate around SME additionality and value for money, we might have expected a more cautious tone this time round. Instead, Connell offered a view similar to his earlier critique, even though much of the underlying data has since been revised.
His proposed solution is to shift a material portion of R&D Tax Credit spending into more directed programmes modelled on the US SBIR system, where government departments place early-stage R&D contracts with innovative firms.
The overall message was that R&D Tax Credits are an expensive, blunt instrument and more of the funding should be transferred to schemes that allow government to act as a lead customer.
International competition
Some may argue that the debate is over and that the UK government now has a settled R&D scheme, at least until the end of the current parliament in 2028 or 2029.
I believe that view is misplaced. Other countries have been strengthening their R&D incentives, not weakening them. Ireland, for instance, has increased the value of its R&D Tax Credit, whilst the US continues to expand support for business-led R&D. Dubai is preparing to introduce a new incentive regime designed to attract global technology companies and high-value R&D investment.
These developments are important because they impact where companies locate R&D centres.
Decisions about where to establish an engineering team or R&D lab are often shaped by national tax policy. The UK is competing in an environment where other nations see R&D support as an increasingly important tool for attracting inward investment. Thirty-four out of thirty-eight OECD countries now offer tax relief for R&D expenditure, with only Costa Rica, Israel, Latvia and Luxembourg not offering an equivalent scheme.
In this context, any renewed effort to depict the UK R&D scheme as a “costly failure” risks creating uncertainty and damaging competitiveness at the same time as other countries are moving in the opposite direction.
Looking ahead…
David Connell’s testimony formed part of a wider House of Lords report published last month titled “Bleeding to death: the science and technology growth emergency”.
The Lords were clear that the UK is good at starting companies but poor at keeping them. If promising firms scale elsewhere, the economic value goes with them, so the report calls for stronger measures to help innovative companies stay and grow in the UK. That is difficult to reconcile with arguments that continue to cast doubt on the value of R&D incentives.
The Lords’ report recognises the concerns around fraud and compliance in R&D Tax Credits, but it also emphasises the strategic value of a stable incentive that supports business-led R&D without picking winners.
Yet, if Connell’s 2021 argument regains traction, renewed pressure to scale back the scheme is possible, even though R&D Tax Credits remain one of the few parts of the UK’s innovation environment that are internationally competitive.
The last four years have shown how easily a flawed narrative can influence government policy.
The danger now is not that R&D Tax Credits are a costly failure, but that continued misinterpretation of the evidence could lead to decisions that undermine the UK’s long-term competitiveness.
You can view also view the article here: LinkedIn
Article written by Rufus Meakin
Rufus Meakin works with tech companies to help ensure their R&D Tax Credit claims are accurate and defendable.
If you would like to discuss any aspect of your R&D Tax Credit claim then please feel free to book an exploratory call here: https://calendly.com/rufusmeakin-uk/r-d-tax-credits-exploratory-call
