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\begin{comment}
Please include the following acknowledgements in any reproductions of this material.
Source document: Kevin A. Bryan and Heidi L. Williams, 2021. 
Figure #: © .  All rights reserved. [Citation with link to source]
Table #: © .  All rights reserved. [Citation with link to source]
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\title[]{Innovation: Market Failures and Public Policies} 
\subtitle{Lecture 3: Taxes and innovation \vspace{3cm}}
\institute[]{\justifying The material covered in these slides is drawn from: Bryan, Kevin and Heidi Williams (2021) "Innovation: Market Failures and Public Policies," Chapter 13 in the \emph{Handbook of Industrial Organization Volume 4}, edited by Kate Ho, Ali Hortacsu, and Alessandro Lizzeri.}
\date{} 

\graphicspath{{graphics/}}

\begin{document}
	
\frame{\titlepage}

\begin{frame}{Market-based innovation policies}

We now turn away from science toward the role of market incentives on innovation

\vspace{6mm}

\begin{itemize}
    \item From Schmookler (1966): ``invention is largely an economic activity which, like other economic activities, is pursued for gain''
    \item Intuition and empirical evidence tell us that changing costs and rewards facing firms can change research investments
\end{itemize}
    
\end{frame}

\begin{frame}{Examples of research incentives}

To start off, we look at some historical examples of inventors responding to changes in incentives

\begin{itemize}
    \item Richard Gatling was known for farming inventions until the 1860s, and then shifted to military implements during the US Civil War {\scriptsize \textcolor{red!75!green!50!blue!25!gray}{[Khan and Sokoloff 1993]}}
    \item Textile inventions augmenting Indian cotton rather than US cotton became more common during the supply disruptions of the US Civil War {\scriptsize \textcolor{red!75!green!50!blue!25!gray}{[Hanlon 2015]}}
    \item As the US population has aged, investments in drug development have shifted towards developing more drugs to treat diseases common in older age groups {\scriptsize \textcolor{red!75!green!50!blue!25!gray}{[Acemoglu and Linn 2004]}}
\end{itemize}

Economic theory and the available data support the idea that incentives should drive research investments. If most scientific advances were to happen via lucky accidents, economics – and policy – would have little role to play.
\end{frame}

\begin{frame}{Designing economic policy}

The government has two levers for shifting the rate and direction of inventive activity:
\begin{itemize}
    \item Reduce costs with tax credits, direct subsidies, or labor market policies such as immigration changes that make it easier for firms to hire specialized workers
    \item Increase expected revenues by changing antitrust policy or awarding market power or payoffs directly via the patent system or prizes
\end{itemize}

\vspace{3mm}

The following four lectures in this series will focus on specific areas of innovation policy: taxes, intellectual property rights, competition, and labor market
    
\end{frame}

\begin{frame}{Introducing taxes}

Advantageous tax
treatment of research expenditures is a market-oriented response which leaves the choice and pursuit of R\&D investments with the private sector

\vspace{3mm}

Several aspects of the US tax code are thought to significantly affect R\&D expenditures
\begin{itemize}
    \item Since the mid-1950s, firms have had the option of fully deducting R\&D in the year it occurs, reducing tax liabilities in the future
    \begin{itemize}
        \item i.e. the tax code subsidizes current R\&D expenditures more than longer-term capital investments
    \end{itemize}
    \item The US federal R\&D tax credit was introduced in 1981 as a temporary policy, and became permanent in 2015
    \item Minnesota was the first state to introduce a state-level R\&D tax credit in 1982, and, in recent decades, state-level R\&D tax credits have become both more common and more generous
\end{itemize}
    
\end{frame}

\begin{frame}{International comparisons}

\begin{itemize}
\item Many countries choose to provide additional tax incentives for R\&D investments, such as R\&D tax credits.
\item In 2015, 28 of 34 OECD countries, as well as a number of non-OECD countries, gave advantageous tax treatment to business R\&D expenditures {\scriptsize \textcolor{red!75!green!50!blue!25!gray}{[Appelt et al. 2016]}}
\end{itemize}

\vspace{6mm}

The figure in the following slide provides one characterization of the cross-country variation in tax support for business R\&D, as measured by forgone revenues and refunds

\end{frame}

\begin{frame}
\frametitle{Direct government spending and government tax support for business R\&D in 2017}
    \begin{center}
    \includegraphics[scale=0.26]{figure4_tax_support_1.pdf}
    \end{center}
\scriptsize \textcolor{red!75!green!50!blue!25!gray}{Notes: Government tax support combines national and sub-national tax support for business R\&D expenditure. Data on national tax support is not available in Israel. Data on sub-national tax support is not available in the US and Spain. Source: Organization for Economic Co-operation and Development (2020)}
\end{frame}

\begin{frame}{More on state tax credits}
\begin{itemize}
    \item Within the US, many states have followed Minnesota in implementing a state-level tax credit
    \item The figure below, replicated from Wilson (2009), shows the increasing frequency and generosity of the credits
\end{itemize}

\begin{center}
    \includegraphics[scale=0.26]{figure5_state_tax_credits_1.pdf}
\end{center}

\end{frame}

\begin{frame}{Effect on user cost of R\&D}
    
Do R\&D expenditures increase when tax-adjusted user cost of R\&D falls?

\vspace{3mm}

\begin{itemize}
\item Several papers estimate this relationship with country-year or state-year panel data  {\scriptsize \textcolor{red!75!green!50!blue!25!gray}{[Bloom et al. 2002 and others]}}
\item Bloom, Van Reenen, and Williams (2019) summarizes the literature: a 10 percent fall in the tax price of R\&D generates at least a 10 percent increase in R\&D in the long-run
\end{itemize}

\vspace{3mm}

Two types of concerns arise with these studies: re-labeling existing expenditures and relocating research investments
    
\end{frame}

\begin{frame}{Re-labeling expenditures}

Studies tend to use self-reported R\&D expenditures as the outcome of interest, so measured R\&D responses to tax changes may reflect re-labeling of existing expenditures rather than true changes in research investments

\vspace{3mm}

\begin{itemize}
    \item What expenditures should or should not be labeled as R\&D is difficult to define, so self-reported R\&D investment figures seem likely to be subject to manipulation
    \item Chen, Liu, Suárez Serrato, and Xu (2021) estimates that around 25\% of the increase in Chinese firms' reported R\&D spending in response to tax cut incentives was due to re-labeling
\end{itemize}
    
\end{frame}


\begin{frame}{Re-labeling expenditures, potential solution}

Potential solution: don't look just at R\&D spending as the outcome of interest
\begin{itemize}
    \item Dechezleprêtre, Einiö, Martin, Nguyen, and Van Reenen (2016) finds that patenting, along the treated margin of relatively small firms, has an elasticity of 2.6 with respect to tax-adjusted user cost and that this R\&D spills over to similar firms who do not directly receive the credit
    \item Pless (2021) investigates the relationship between R\&D grants and tax credits, finding results dependent on firm size
\end{itemize}
    
\end{frame}


\begin{frame}{Relocation of research}

Country- or state-level R\&D tax credit policies may simply incentivize the relocation of research investments to areas with more generous tax incentives rather than raise aggregate R\&D

\vspace{3mm}

\begin{itemize}
    \item Wilson (2009) finds that lower R\&D tax rates attract more R\&D investment; offset by lower R\&D spending in high tax states
    \item A series of empirical papers find evidence of relocation at the level of individual scientists/inventors
    {\scriptsize \textcolor{red!75!green!50!blue!25!gray}{[Akcigit et al. 2016, Moretti and Wilson 2014, 2017]}}
\end{itemize}

\vspace{3mm}

Evidence of a relocation response does not imply that the aggregate effects of R\&D tax credits are zero

\end{frame}

\begin{frame}{Quantifying tax credit effects}

Several papers have attempted to quantify the effect of tax credits on aggregate levels of R\&D, taking relocation into account
    
\begin{itemize}
    \item Akcigit, Grigsby, Nicholas, and Stantcheva (2018) finds evidence of relocation but that the aggregate effects of tax incentives on innovation are nonetheless substantial
    \item Other papers have analyzed at a more conceptual level whether top income tax rates should be expected to have aggregate effects on R\&D
    {\scriptsize \textcolor{red!75!green!50!blue!25!gray}{[Bell et al. 2019, Jones 2019]}}
\end{itemize}

Future work: Can we relate the magnitude of these tax policy responses to the magnitude of the gap between social and private returns to research investments?
    
\end{frame}

\begin{frame}{Patent boxes}

Patent boxes apply a lower tax rate to revenues linked to patents

\vspace{3mm}

\begin{itemize}
    \item Patent boxes were first introduced in the 1970s, and are used in many European countries
    \item Concern: the policy raises the risk of inducing tax competition
    \item Recent evidence shows that high-value patents are relocated to markets with patent boxes {\scriptsize \textcolor{red!75!green!50!blue!25!gray}{[Gaessler et al. 2018, Alstadsæter et al. 2018]}}
    \item The papers don't find evidence of either higher R\&D expenditures in markets with patent boxes or aggregate increases in R\&D investments
\end{itemize}
    
\end{frame}

\begin{frame}{More concerns on patent boxes}

At a conceptual level, Hall (forthcoming) provides an insightful comparison of R\&D tax credits and patent
boxes
\begin{itemize}
    \item R\&D tax credits target inputs (R\&D spending), whereas patent boxes target an output (profits) and only cover patentable innovations
    \item Further, patent boxes effectively subsidize patent assertion and provide incentives to renew patents that would otherwise be abandoned
\end{itemize}

Bloom, Van Reenen, and Williams (2019): logic and empirical evidence suggest patent boxes are likely to be a harmful form of tax competition relative to well-designed R\&D tax credit policies

\end{frame}

\begin{frame}{Public funding of private research }

Governments often subsidize research investments at private firms, but evidence on subsidy effects has been sparse

\vspace{3mm}

\begin{itemize}
    \item Lerner (1999) and Howell (2017) find large, positive effects from the US Small Business Innovation Research (SBIR) program
    \item Other papers provide evidence on similar programs in Europe {\scriptsize \textcolor{red!75!green!50!blue!25!gray}{[Bronzini and Iachini 2014, Einiö 2014, Santoleri et al. 2020]}}
    \item Caveat from Bhattacharya (forthcoming): government agencies may be maximizing objectives other than social welfare
    \begin{itemize}
        \item e.g. Department of Defense SBIR contracts are inefficient, in part to minimize acquisition costs
    \end{itemize}
\end{itemize}
    
\end{frame}

\begin{frame}{Summing up}
\begin{itemize}
    \item Taxes can be an important government policy lever to control the rate and direction of inventive activity
    \begin{itemize}
        \item Federal and state tax credits can encourage firm investment in R\&D
        \item Governments can also use patent boxes and direct subsidies to motivate private research investments
    \end{itemize}
    \item The aggregate effects of tax policies on innovation are difficult to quantify
    \begin{itemize}
        \item Firms can re-label existing expenditures as R\&D to reap policy benefits without changing behavior
        \item Firms and inventors can relocate to areas with more generous tax incentives without raising aggregate R\&D
    \end{itemize}
    \item Empirical evidence generally shows positive effects of tax credits on inventive activity
\end{itemize}

\end{frame}

\end{document}