Hall, Bronwyn H. (ed.), ‘Tax Policy for Innovation’, Innovation and Public Policy (Chicago, IL, 2022; online edn, Chicago Scholarship Online, 22 Sept. 2022), https://doi.org/10.7208/chicago/9780226805597.003.0006, accessed 17 Dec. 2023.

1. Impact of Taxation on Innovation:

• Main Idea: Taxes affect how much companies and individuals innovate. Higher taxes can lead to less innovation.
• Study by Akcigit et al. (2018): This research found that in the U.S., higher state-level personal and corporate taxes correlate with reduced innovation. This was measured using patents and their quality (citations). The negative impact was more pronounced for firms than individuals.

2. Economics of Innovation:

• Key Concept: Innovation often benefits others, not just the innovator. This means companies might not invest enough in research and development (R&D) because others can copy their ideas. Since the 1950s and 60s, economists like Arrow and Nelson noted that R&D benefits the broader economy.
• Challenges in Innovation: Innovators face risks and uncertainties, and it’s tough for them to get funding, especially for new and small companies. Small and new firms face high financing costs for R&D due to risks, uncertainties, and asymmetric information issues between innovators and financiers.

3. Government’s Role in Promoting Innovation:

• Main Point: Governments should support research and innovation, especially in areas like health and environment, as these are public goods that benefit everyone.
• Double Externality Problem: There’s a double benefit (or externality) to government-funded environmental innovation, but it’s often not enough because of its non-exclusive nature.
• Policy Options: Governments use tax incentives to encourage private innovation expenditure, and direct spending for projects that might not be profitable but are socially valuable.

4. Policies for Encouraging Innovation:

• Approaches: Governments use two main strategies:
  1. Incentives: Like tax breaks to encourage companies to innovate.
  2. Direct Spending: Government funding research directly.

5. Tax Measures for Innovation:

• R&D Tax Credits and Superdeductions: These are based on a firm’s R&D spending. For instance, an R&D superdeduction allows for more than 100% expensing of R&D costs.
• IP Boxes: Aimed at reducing tax rates on income from intellectual property. This is to counter the trend of moving IP to low-tax jurisdictions.
• Investment Tax Credits: These reduce the cost of acquiring new equipment and IT, which are significant parts of innovation expenditure.
• Debt vs. Equity Finance: The tax system’s treatment of debt and equity can influence innovation funding, with a bias towards debt due to interest expense deductibility.

6. Issues with R&D Tax Credits:

• Challenge: It’s hard to figure out how much extra research a company does because of these tax breaks.  Countries have struggled with whether to subsidize all R&D spending or just the incremental amount beyond what firms would do anyway.
• Solution Variations: Different countries have tried various ways to make these credits more effective. The Netherlands introduced reduced social charges on R&D employment, which effectively lowers the firm’s costs directly.

7. Evaluating the Success of Tax Policies:

• R&D Tax Credits: Generally successful in increasing research by businesses.
• Patent Boxes: They prevent companies from moving their patents to other countries, but there’s little evidence they increase actual research or new inventions.

8. Broader Policy Considerations:

• Sufficient Support for R&D?: There’s ongoing debate about whether current government supports, like tax subsidies, are enough given the high social returns of R&D.
• IP Boxes vs. R&D Credits: IP boxes may not be the ideal solution for broadly incentivizing innovation, as they reward successful R&D but don’t necessarily stimulate new research.

In Simple Terms:

• Taxes and Innovation: High taxes can slow down the creation of new ideas and products.
• Why Governments Get Involved: Innovations help everyone, not just the people who create them. But companies might not invest enough in new ideas because it’s risky, and others can steal their ideas.
• What Governments Do: They give tax breaks and sometimes fund research directly to encourage companies to come up with new things, especially in important areas like health and the environment.
• Tax Breaks for Innovation: Companies can get tax benefits if they spend money on research or create new inventions. But it’s tricky to make sure these benefits really lead to more innovation.
• Effectiveness: Tax breaks for research seem to work well in getting companies to do more research. But tax breaks for earning money from inventions (like patents) might not be as effective in creating new inventions.