LegiStorm

Summary:

Economists generally agree that government support for private investment in research and development (R&D) is useful in correcting a market failure that predisposes most companies to invest less for that purpose than the overall economic benefits from R&D investments would warrant. The market failure stems from a company’s inability to capture all the returns to its R&D investments as a result of the spillover effects of successful R&D investments. Most governments offer some kind of support for R&D, including tax incentives for business R&D investments. The U.S. government provides a tax credit for qualified research under Section 41 of the federal tax code and a full expensing allowance for qualified research expenditures under Section 174, but no patent box. As part of the debate in Congress over reforming the federal income tax, some have expressed support for the adoption of a patent box. Such a box is a tax subsidy that applies to the returns to successful R&D investments. In effect, a patent box partially compensates companies for the returns that spill over to other actors, such as competing companies. Countries typically adopt patent boxes with three key goals in mind: (1) increasing tax revenue by encouraging the repatriation of intellectual property (IP) held abroad and discouraging domestic companies from transferring IP to foreign subsidiaries in low-tax countries; (2) expanding domestic innovative activities; and (3) stimulating growth in domestic high-paying jobs. Every patent box now in use is built around two key elements: the nature of the tax subsidy it offers and the scope of its application. The tax subsidy typically comes in two forms: a deduction or exemption from a company’s gross income or a separate, preferential tax rate for qualified intellectual property (IP) income. A patent box’s scope addresses such issues as the kinds of IP and IP-related income that qualify for the tax subsidy. At the end of 2015, 16 countries offered a patent box; all but three of them were members of the Organization of Economic Cooperation and Development. Among the nine largest patent-box countries as a location for business R&D investment, effective patent-box tax rates ranged from 5.0% to 17.1%. Each patent box applied to existing and new patented innovations. Only one of the nine countries did not offer separate tax incentives for domestic R&D investment. It stands to reason that the industries most likely to benefit from patent boxes are those that use patents intensively. According to a 2016 report by the U.S. Patent and Trademark Office and the U. S. Department of Commerce, two industries are the most intensive users of patents, as measured by the number of patents granted to them per 1,000 full-time employees: chemical manufacturing (including pharmaceuticals) and computer and electronic equipment. The prospect of the United States adopting a patent box raises several policy issues. One issue concerns the effectiveness of patent boxes in achieving their goals. The empirical literature on patent boxes is relatively meager, since most existing patent boxes have come into use since 2007. Nonetheless, a handful of academic studies have looked at the actual or probable effects of patent boxes on several indicators of success. They found that patent registration was responsive to cuts in tax rates on the income from patents; there is no evidence that patent boxes increase host-country revenues; and patent boxes have done little to boost investment in innovation in host countries. Patent boxes also raise questions about the cost to companies of complying with the rules and the cost to tax authorities of issuing regulations and enforcing them; whether a patent box is warranted on economic grounds; and their incentive effect, especially when coupled with R&D tax incentives.