Innovation is something that is widely sought after by both individual organizations and governments, so it’s no surprise that a wide range of policies are in place to try and support innovation within countries. The success of these policies is illustrated in the likes of the Global Innovation Index, from INSEAD, which compiles data on hundreds of metrics to determine the success of countries in everything from the ease of setting up a business to intellectual capacity and financial infrastructure.
One factor that must surely play a significant role is that of taxation, and countries adopt a variety of tax policies to try and nudge companies to behave more innovatively. A recent study set out to explore just how big an impact tax can play in terms of innovation, and especially whether higher taxes can inhibit investment in innovation.
The authors compile data on the tax rates of both corporations and individuals across the United States during the 20th century, before collecting data on patents registered and R&D activity by companies during the same timeframe.
Fluctuating fortunes
Perhaps unsurprisingly, there has been considerable fluctuation in tax policies over the course of the 20th century, with periods of high taxation interspersed with periods of much lower tax levels. The authors’ hypothesis is that higher taxes reduce the incentive to invest in innovation, as the fruits of that investment will not be quite so fruitful.
The analysis suggests that higher taxes do indeed appear to suppress innovation, and appear to do so to quite a significant extent, both at the individual inventor level and at a state level. The study found that a 1% rise in either the top rate of tax or the median rate was linked with a 4% fall in patents, citations and inventors, with a 5% decline in the best inventors operating in a particular state. Likewise, a 1% rise in the top corporate tax rate was linked with a 6% fall in patents, a 5.5% fall in citations and 5% fall in inventors.
The authors illustrate this trend via the example of Michigan, which introduced the personal income tax in 1967 and the corporate income tax in 1968. These moves were followed by a reduction in patents, inventors and patent citations, which the authors believe are directly linked to the introduction of the taxes.
Policy implications
Whilst tax is not the only reason behind innovation, and certainly not the location of innovation, with the Global Innovation Index identifying over 100 different factors that play a role, the study is nonetheless interesting in highlighting the role tax can play in encouraging innovation in an area. This is especially so in areas where mobility is high and both individuals and companies have the possibility to locate in a large number of places.
The authors believe that their findings highlight the important role both corporate and personal taxes play in encouraging innovation, and that their role goes beyond R&D tax credits and the like that form much of innovation policy today.
They argue that taxation policy in many countries today is often framed in terms of its ability to redistribute wealth throughout society, but they hope that their work also highlights the impact this can have on the innovative output of that society, which given the role economic growth plays in the wellbeing of the society as a whole should not be underestimated.
Whilst they accept that more work is needed to explore whether similar results emerge in other countries, they nonetheless believe their findings are a vital first step towards understanding the link between taxation levels and innovation.
