Abstract: R&D activity is the engine of innovation. Institutional arrangements and R&D investment are key factors and important constraint conditions affecting innovation. This paper discussed the effect of local government behavior and its R&D investment to innovation. Firstly, the author introduced panel data model containing Dummy Variables to analysis the relationship between them and regional differences. Secondly, a threshold regression model was applied to study the deep-seated reasons of the difference. The results show that the optimal value of the fiscal decentralization and the government R&D investment in theory exist. If they deviate from the optimal value, they will affect the level of innovation. Therefore, it is necessary to maintain a moderate fiscal decentralization and to ensure a reasonable scale of government R&D investment. Based on the empirical results, the author proposed the direction of further research.