Patent Boxes: Innovation in Tax Policy and Tax Policy for Innovation

October 17, 2011

An effective corporate tax system reflects current economic realities. As such, the U.S. corporate tax system is in need of reform, for it reflects economic realities of a generation ago. Today, the U.S. economy faces intense global competition for economic advantage, particularly in innovation-based, higher wage industries. Moreover, the economy is based more on innovation and intellectual property (IP).1 IP is also more mobile, as companies can perform R&D and patent in countries around the world. Therefore, nations that hope to grow and attract innovation based business establishments need tax policies that promote both the conduct of research and its commercialization.

Toward that end, a number of countries recently have adopted or expanded R&D tax incentives as well as developed new tax incentives to spur the commercialization of that R&D. These incentives or “patent boxes” (so-called because there is a box to tick on the tax form) allow corporate income from the sale of patented products to be taxed at a lower rate than other income. Eight nations (seven in Europe) have enacted patent box regimes that incentivize firms to patent or produce other related innovations. And a ninth, the UK, is set to put in place the incentive in 2013.

Proponents of patent boxes argue that they increase country competitiveness not only by spurring firms to invest more in innovation but also by providing a more competitive corporate tax climate for increasingly innovation-based firms. Skeptics claim that patent boxes do not actually address market failure because firms already have all the incentives they need to commercialize innovation in the marketplace.

This report seeks to inform the debate on whether patent boxes can help promote R&D and commercialization and if a patent box is appropriate for the United States. It articulates two economic rationales for why the United States should follow our European…

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