Academic journal article NBER Reporter

Taxation and Innovation

Academic journal article NBER Reporter

Taxation and Innovation

Article excerpt

Innovation is the source of technological progress and, ultimately, the main driver of long-run economic growth. In recent work with several co-authors, we have shown that the U.S. states that produced the most innovations also grew fastest over the 100-year period from 1900 to 2000. (1) We also have documented that innovation is strongly associated with social mobility. U.S. regions that experienced more innovation also witnessed much stronger intergenerational and social mobility, especially when innovations were attributable to new entrant firms. Innovation also correlates strongly with top income inequality, but not so much with measures of inequality such as the Gini or the 90/10 ratio, and is associated with greater well-being across the United States. (2,3)

Given all the important consequences of innovation, it is essential to understand how public policies impact innovation in the United States and across the world. Our joint research agenda explores the interplay between taxation and innovation.

Major changes in U.S. tax policy, such as those in the Tax Cuts and Jobs Act of 2017, raise questions about whether higher taxes stifle growth, productivity, and innovation.

If innovation, like many other economic outcomes, is the result of intentional effort and investment, then higher taxes will reduce the expected net return to these inputs and lead to less innovation. Yet for at least some path-breaking superstar inventors from history, such as Thomas Edison, Alexander Graham Bell, and Nikola Tesla, the picture that comes to mind is one of hard-working, enthusiastic scientists who are unconcerned with financial incentives and only strive for intellectual achievement.

Related questions are whether taxes impact the quality of innovation, where inventors decide to locate, and what firms they work for. In addition, there is a question of whether taxes influence where companies allocate R&D resources and how many researchers they employ.

Answers to these questions are still lacking, and there is a scarcity of empirical evidence. The gap in our understanding is especially large when it comes to the effects of tax policy on technological development over the long run.

Theory and Empirics of Taxation and Innovation

There are two complementary dimensions along which to think about the interplay between taxation and innovation. First, taxation on personal or corporate income or wealth may affect innovation. This may be an unwelcome byproduct of taxes that are set for completely unrelated goals, such as to raise revenues. Thus, reduced innovation could be one of the efficiency costs of taxation; this could affect the assessment of optimal taxes, since the elasticity of innovation with respect to taxes would influence the elasticities that enter into the optimal tax formulas. (4) (,) (5) This underscores the importance of quantifying the elasticity of innovation to taxation along all the relevant margins. Second, tax policy could be designed intentionally so as not to hurt, or even to stimulate, innovation.

Our research agenda on taxation and innovation seeks to understand and quantify the effects of taxation--of personal income, corporate income, and wealth--on innovation by firms and individuals. How do taxes shape all these agents' choices leading up to innovations? Our empirical studies are based on modern-day data--European patent office data since 1975, for example--and on long-run historical data, such as the universe of U.S. inventors since 1836. Theoretically and quantitatively, we study the design of decentralized innovation policies: combinations of taxes, tax credits, and subsidies that can make agents internalize the spillovers from innovations and foster innovation. We illustrate our research approach by focusing on three distinct studies.

Taxation and Innovation in the 20th Century

Although the United States experienced major changes in its tax code throughout the 20th century, we currently do not know how these tax changes influenced innovation at either the individual or corporate level. …

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