Taxes and innovation

A new paper finds that tax rates (corporate and individual) have large effects on innovation:

Our main findings can therefore be summarized as follows. Taxation – in the form of both personal income taxes and corporate income taxes – matters for innovation along the intensive and extensive margins, and both at the micro and macro levels. Taxes affect the amount of innovation, the quality of innovation, and the location of inventive activity. The effects are economically large especially at the macro state-level, where cross-state spillovers and extensive margin location and entry decisions compound the micro, individual-level elasticities. Not all the effects of taxes at the macro-level are accounted for by cross-state business stealing or spillovers. Corporate inventors are most sensitive to taxation; and positive agglomeration effects play an important role, perhaps in offering a type of compensating differential for taxation.

This goes against my prior, at least to some degree. I would have said before that incentives do matter for innovation — and that that includes taxes — but that the effect of taxes on innovation may not be that large. Here’s what I wrote a few years ago:

Of course benefits are only one side of the ledger. Taxes are just as often held up as a threat to entrepreneurship and a dynamic economy. A lower capital gains tax rate does seem to be associated with a greater supply of entrepreneurs. But keeping the capital gains rate low to help startups is incredibly inefficient, since only a small portion of realized capital gains are from entrepreneurial activity. As Harvard Business School professors Paul Gompers and Josh Lerner write, “policies that increase the relative attractiveness of becoming an entrepreneur and promote technology innovation probably would have more of an effect on venture capital investments than an across the board cut in the capital gains tax rate.”

Instead of preserving low tax rates, entrepreneur-friendly tax reform would encourage startup investment by shifting the tax code away from its current bias for debt over equity, and could preserve or expand key tax credits like the exemption for long-term investment in small businesses.

Here are my notes on taxes and economic growth in general.

I remain interested in how efficient low corporate, income, and capital gains taxes are or aren’t for incentivizing innovation, and how the tax code and other incentives might provide more tailored options. But taxes do seem to have a meaningful effect.

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