Virginia provides 11 incentives to promote science and technology economic activity by businesses in the state. Spending on these incentives totaled $39 million in FY20 and $176 million between FY11 and FY20. More than half (56 percent) of this amount was for the state’s three research and development (R&D) incentives. Spending on science and technology incentives has grown over time and reached 10 percent of spending on state economic development incentives in FY20, primarily because of adoption of the major R&D tax credit.

WHAT WE FOUND

Research indicates R&D incentives are effective, but Virginia’s are too small to meaningfully increase statewide business R&D activity overall

Virginia offers three R&D tax incentives—the major R&D tax credit, the R&D expenses tax credit, and the R&D sales tax exemption—to encourage private R&D activity in the state. Research suggests R&D tax credits increase R&D activity, particularly for smaller companies that are more likely to face financial constraints. Virginia’s R&D tax credits likely have increased R&D expenditures and activity for many of the companies using them. However, they have had limited impact on increasing statewide R&D activity because the total value of the credits over the last 10 years has equaled only 0.15 percent of overall R&D spending in the state during that period. Even significant increases in funding for the tax credits would likely not have a meaningful impact on the state’s business R&D activity: analysis suggests doubling the credit would only increase the state’s business R&D intensity slightly. Other factors likely have a greater influence on R&D activity overall in the state, such as the strength of the economy and industry mix.

The measurable economic benefits and returns in state revenue from R&D incentives are negligible based on economic impact modeling, but the actual benefits are likely greater. The analysis does not capture the spillover benefits to other companies and only captures short-term impacts of the R&D tax credits. Though understated, the economic benefits of the R&D expenses tax credit are slightly higher than the major R&D tax credit, and this is likely because the R&D expenses tax credit targets smaller companies and has more features of a well-designed tax credit.

Tax credit to encourage private investment in high-tech startup businesses has little impact on startup growth

Virginia offers the Qualified Equity and Subordinated Debt Investments Tax Credit (angel investment tax credit) to encourage private equity investment in high-tech startup companies. The credit has had little impact on business startup growth because it is not well designed to ensure investments are made in startups with growth potential. The incentive does not target professional, experienced investors. In addition, startups assisted by investors receiving angel investment tax credits have not leveraged much additional private investment, which they need to grow. Because of these factors and the credit’s lack of job creation requirements in return for receiving the incentive, this credit is estimated to have a negligible economic benefit and return in state revenue.

State’s programs providing financial assistance directly to startups help businesses innovate and grow

Virginia offers two programs that provide financial assistance directly to startups. The Growth Acceleration Program (GAP) Funds make early, seed-stage equity investments in small technology and life sciences startups, and the Commonwealth Research Commercialization Fund (CRCF) program provides grants to small, high-tech startups that are also in very early stages of development. Both programs report high investment leverage rates, meaning projects have received additional private investments needed to grow. The CRCF program has also helped Virginia remain competitive in receiving federal grant funding for small business innovation and research. The programs are well designed with a rigorous application and review process for awarding program funds, and program staff provide support to the assisted startups.

The GAP Funds program has a high economic benefit and return in revenue, in part, because proceeds from the sale, move, or public offering of a company in the program can fund future equity investments. The CRCF program has a low measurable economic benefit because grant recipients experienced low levels of employment growth, which is typical for this type of program because it leverages universities for research-related activity. However, steps are being taken to broaden eligibility to more sectors, which may enable faster growing projects to be funded, increasing the impacts of the program.

Space tax incentives have minimal impact on space activity

Virginia offers three tax incentives to support increased space flight activity in Virginia, but the incentives do not have much influence on increasing space activity in the state. They also have negligible economic benefits and returns in state revenue because most of the components for space flight vehicles launched in Virginia come from out-of-state or international suppliers.

Factors other than the incentives are much more influential in attracting space flight activity to Virginia. Virginia’s Mid-Atlantic Regional Spaceport (MARS) is one of four facilities nationally that has vertical launch facilities, and it has locational advantages on the East Coast. Virginia has also provided significant funding directly to support MARS, including $15 million in annual operating appropriations, more than $50 million in additional appropriations for infrastructure, and $28 million in grants to companies to support infrastructure development at MARS.

WHAT WE RECOMMEND

Legislative action

• Prioritize the R&D tax credits for smaller companies that will likely benefit more from them.

• Improve the effectiveness of the major R&D tax credit by adjusting the reimbursement structure and prioritizing research conducted with higher education institutions.

• Eliminate the angel investment tax credit.

• Eliminate the space flight income tax subtractions after the current contract to resupply the International Space Station expires.

The complete list of recommendations and options is available on page v.