In the competition to attract and retain global corporate investment, tax policy is often seen as one of the most immediate and potent levers that legislators can pull. This is especially true given the ability of multinational companies to move business and capital across borders. These transnational flows often take with them the jobs, the R&D, and the innovations that drive and sustain long-term growth. Intellectual property (IP)—including copyrights, trademarks, and patents—is particularly mobile as an intangible asset.
In April of next year, the United Kingdom will become the latest country to introduce a corporate tax incentive known as a “patent box,” a policy that grants companies a significant tax break on profits attributed to IP. The policy’s name refers to the box that is physically checked on the tax form.
The UK patent box, which hopes to attract innovative industries and all their economic fruits, will allow corporations to apply a reduced 10 percent rate to income from patents- versus a headline rate of 23 percent. Patent box policies have also been deployed recently in Holland and Belgium (2007), as well as in Spain and Luxembourg (2008). The Dutch “innovation box” goes even further by including a broader class of IP and a lower rate of 5 percent.
As other nations jockey for position, the United States has slipped well behind. The current U.S. corporate tax regime hasn’t undergone a major facelift since 1986. And the current system is doubly flawed, combining the highest top tax rate in the world, at 35 percent, with a host of complex subsidies and loopholes that add to inefficiency. While both parties have acknowledged a need to cut the top rate and end many of the tax subsidies, one incentive that most policymakers—including President Obama and Mitt Romney—would like to preserve is the Research and Experiment (R&E, sometimes R&D) tax credit.
Most economists agree that unlike many other corporate tax incentives, the R&D credit deserves special treatment because it provides a wellspring of growth and has social returns that are not captured by businesses—a market failure. But despite the near consensus, Washington has proved unable to make the R&D tax credit a permanent fixture of the U.S. code. It has expired and been renewed thirteen times (often retroactively) since 1981, sunsetting yet again last January. The impermanence of the credit in the U.S., as with many tax policies, has made it less effective as businesses are reluctant to change behavior given uncertainty.
“What’s happened traditionally every year is that in the fourth quarter or maybe even beyond the fourth quarter, the R&D credit is enacted and we have to then figure out the deduction for the whole year’s credit,” said Bruce Lassman, vice president of international tax at IBM. “So that’s kind of a nerve-wracking thing. It’s difficult to manage your affairs when you have a legislative situation like that.”
While there is broad consensus that the R&D tax credit should be made permanent, the idea of adding a patent box tax incentive has not been part of the debate in the United States. If adopted in concert with the R&D credit, a U.S. innovation box could supply a back-end incentive in the so-called innovation value chain. In other words, it would target the back end, the income from innovations, while the R&D credit incentivizes the front end, or the underlying research. While the latter is more important because the R&D provides spillover social benefits, the revenue incentive provided by an innovation box would likely sweeten the deal and encourage companies to maintain or expand IP-intensive activities in the United States.
There are big questions, however about the costs of such an approach. An innovation tax incentive, depending on the reduced rate and a host of other specifics, would certainly hit the Treasury hard if it’s not implemented as part of broader reforms to the tax code.