The Popularity Of Patent Boxes

TAXTax reformers and economists usually hate tax breaks. The way they see it is like this: Unprincipled politicians can?t resist giving away goodies. So our tax code is littered with complications designed to channel subsidies to the well-connected. This makes a mess of the free market. The economy?s efficiency suffers. And the rest of us are stuck with higher tax rates.

There are rare exceptions, however, to the general rule. Sometimes ? and we must emphasize how rare it is ? targeted tax breaks can help growth.

In the course of doing business, firms sometimes make and do things that affect the rest of the economy, but the costs and benefits are not fully reflected in the firm?s bottom line. If those things are bad, like emissions of sulfur, the government can tax them to get the economy working properly again. If the things are good, like new knowledge that broadly supports advances in science, the government can provide tax subsidies to boost knowledge creation up to optimal levels.

So, while it would be foolhardy for the government to get into the business of making furniture, it makes economic sense for it to directly fund research. And while there is every reason to oppose tax subsidies for particular activities like watch-making or carpentry, it makes sense to provide tax subsidies for scientists and engineers doing research and development.

That?s why since 1981 we have had a tax credit for industrial research and development. Less well known, but just as important, is the provision in our law since 1954 that allows businesses to write-off their research expenses in the year they are incurred. (Under general principles investment in research, like investment in plant and equipment, should be written off over several years.)

Now several prominent members of Congress want to provide another tax break for research. At first glance, this seems like a very good idea since the usual objections to tax breaks don?t apply. And most regular people understand that the competitiveness of our nation ? or in politics-speak, the availability of high-paying jobs ? depends on technology.

The new tax break is called a patent box. (The ?box? referred to here is the box checked on tax forms in Europe where this idea originated.) The general idea is that income from technology pays tax at a substantially lower rate than other income. So if under tax reform we could get the corporate rate down to 28 percent, patent box income would be taxed at a 14 percent rate.

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