An IMF working paper concludes that R&D subsidies can significantly boost innovation, employment and economic growth, but their effectiveness depends on the availability of highly skilled researchers. The study warns that labour shortages can limit the benefits of tax incentives, increase inequality and even crowd out private R&D, while highlighting education investment and broader growth policies as important complements to innovation support measures.
An IMF working paper with the title “Innovation, Human Capital, and Taxation: Evidence from a Structural Model of the Canadian Economy”, written by Sandra Valentina Lizarazo Ruiz, was released in June 2026.The working paper looked at the effectiveness of research and development (R&D) subsidies in promoting innovation and long-term economic growth, examining the role of labour market constraints and distributional effects.
The outcome of the study suggested that R&D incentives can boost innovation, employment and growth if the right conditions are present. The effect of the policy is significant when the supply of high-human-capital labour is sufficiently elastic, as the subsidies can generate increases in innovation, technology accumulation and output growth that are greater than the effects of alternative fiscal policies.
The study indicates that the effectiveness of R&D subsidies is limited by the availability of researchers. If there is an inelastic supply of scientists to perform research, the subsidies will mostly lead to an increase in wages instead of an expansion of innovative activity. This could crowd out private R&D and even lead to a reduction in economic growth. Innovation policy should therefore be assessed in relation to the underlying structure of the labour market.
One downside to R&D subsidies is that they can increase income inequality by disproportionately benefiting high-income individuals working in research. When the labour supply in research is limited, subsidies such as R&D tax incentives may also increase poverty by reducing aggregate output and affecting the income distribution. This is an important consideration for policy designers who must look at the elasticity of the labour supply in the research area.
Alternative policies to promote innovation and growth could involve reductions in taxes on investment, promoting capital deepening and resulting in positive effects even if there is a limited pool of labour for research. Another policy for growth is to increase spending on higher education, resulting in an expansion of the supply of high-human-capital labour. Although these policies are not so strong as R&D subsidies in promoting innovation, they can deliver gains in a broader range of activities.
The study found that changes in personal income tax do not have very large effects on innovation and growth when applied as an incentive to research. Lower income taxes can improve incentives for human capital accumulation and for individuals to engage in entrepreneurial activity. The impact is small by comparison to more targeted policies such as R&D subsidies.
The results of the study indicate that the most effective innovation strategy could be to combine R&D subsidies with measures that expand the supply of high-human-capital workers and reduce distortions to investment. Investments in education can enhance the effectiveness of R&D subsidies by increasing the supply of scientist engaging in research. A coordinated policy approach where innovation policy and education policy are combined could lead to more effective outcomes.
The authors note that further research could explore the role of sectoral targeting and asymmetric knowledge spillovers across different industries. Future studies could look at how advances in artificial intelligence (AI) may change the relationship between research capital and scientific labour. The use of AI could potentially relax some of the talent constraints by broadening the number of people who can carry out the research work.
