Final answer:
Without external benefits, the demand for borrowing and investing in R&D is likely to be lower. Tax breaks for research and development, like the R&E tax credit, encourage investment by improving cost-effectiveness for firms, with studies showing a high multiplier effect on R&D spending.
Step-by-step explanation:
Expensing all R&D costs associated with internally created intangible assets results in an immediate charge to a company’s income statement, which reduces reported net income in the period the costs are incurred. When a company invests heavily in R&D, these investments create positive externalities such as technology spillovers that benefit society and other businesses, which may not be reflected on the company's own financial statements. In the absence of external benefits, or positive externalities, the demand for borrowing and investing in R&D is likely to be lower, as the private returns on such investments would decrease without the additional societal or third-party benefits.
Government policies such as tax breaks for research and development, signified by the R&E tax credit, exist to encourage firms to invest more in R&D by making it more cost-effective. Studies have found that for every dollar of tax credit, firms are likely to invest at least an equal amount into R&D, with some studies suggesting that the benefit to cost ratio could be as high as 2 or even 2.96. This implies a high multiplier effect where the tax credit not only offsets the costs but also encourages additional private sector investment in R&D.
If external benefits are not present, firms have less economic incentive to invest in R&D, as the potential for broader impacts that could return value to the firm, directly or indirectly, is reduced. This could result in decreased research activities. However, government incentives like the R&E tax credit can counterbalance this by enhancing the private return on R&D investments.