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March 11 — The U.S. shouldn't cut taxes on intellectual property income through a “patent box,” or innovation box, according to a top White House official—but a number of academics disagree.
The debate has been driven by the increasing popularity of such tax regimes elsewhere in the world as other jurisdictions seek to attract mobile capital and associated high-technology, high-income workers.
Innovation box proponents, which include drug development and tech sector companies, said the U.S. risks falling further behind the pack on cross-border taxes if no tax breaks on intellectual property income get adopted. But the existing tax credit for research and development is a more efficient subsidy than creating a new benefit for commercialization, Council of Economic Advisers Chairman Jason Furman said March 11.
“The R&D credit is a cost-effective way to create an incentive for innovation,” he said at a forum on intellectual property taxation at the Georgetown University Law Center. “The innovation box is not.”
A poorly implemented box can compound existing problems, too, said Furman. He declined to comment after his speech when asked about a proposal to discourage inversions through a so-called exit tax that Democratic presidential candidate Hillary Clinton has floated on the campaign trail and Democratic senators have introduced as legislation.
Furman's patent box remarks at the International Tax Policy Forum reinforced similar sentiments offered by others in President Barack Obama's administration, including Treasury Secretary Jacob J. Lew, who dismissed the idea during a House Ways and Means Committee hearing last month.
Cost Among Concerns
Furman pointed out potentially high costs as a leading patent box concern, particularly relative to expenses associated with the R&D credit, as well as other issues.
In societal terms, the R&D credit tends to support investments in innovations that have large social benefits but may be difficult to directly commercialize, whereas a patent box would prop up more profitable research that may not yield as proportional a social return, Furman said.
In addition, the R&D credit is proportional to the amount of research, while an innovation box is proportional to the return. The R&D credit subsidizes new research, but an innovation box would reward old capital. The R&D credit leads to better business cash flow than a back-ended subsidy like a patent box would, Furman said.
He pitched Obama's proposal to expand the newly permanent R&D credit by boosting the alternative credit to 17 percent from 14 percent as better than a patent box.
Draft patent box legislation came out last summer from Rep. Charles Boustany Jr. (R-La.), chairman of the Ways and Means Tax Policy Subcommittee, who has promised an update. It is expected to be part of legislation to establish a dividend exemption on U.S. companies’ overseas profits and cut the overall corporate tax rate, a bill Boustany has said he wants to introduce by March 31 (37 DTR G-3, 2/25/16).
An Elusive Answer
A panel discussion following Furman's remarks featured several tax academics who debated whether the U.S. should introduce an innovation box into its tax system, and the answer proved difficult.
One of the main hurdles, according to the panel, was getting to a point where the proposed innovation box would be both politically possible and economically viable. Other confounding factors include the types of intellectual property that would qualify for the break, the scope of income derived from the intellectual property that would receive the benefit and whether to require that research activities take place in the same jurisdiction offering a patent box, as endorsed by the Organization for Economic Cooperation and Development.
According to Itai Grinberg, an associate professor of law at Georgetown, in addition to tax break incentives pushing R&D initiatives into more friendly jurisdictions, they might also move to minimize audit risks.
“We need to focus on how the patent box interacts with the global establishment,” Grinberg said, adding the question of whether the U.S. actually needs to respond to the popularity of the patent box abroad, or just ignore it, needed answering.
From a global perspective, the U.S. has more freedom than European countries to finagle tax policy because the U.S. isn't locked into European Union treaties, said Michael J. Graetz, a professor of tax law at Columbia Law School.
Missing the Boat?
But while some see modifying U.S. tax policy in response to global tax competition as smart strategy, the possibility of not acting at all is also an option, said James R. Hines Jr., a professor of law at the University of Michigan.
“Should we adapt our tax policy in response? In theory you do want to modify in response to foreign tax policies, but not always copy them,” Hines said.
Alan J. Auerbach, a professor of economics and law at the University of California at Berkeley, said no definitive, empirical evidence points to the fact that innovation boxes result in various forms of innovation growth such as productivity. Revenue losses also give rise to questions about what sectors would get hit with higher taxes to make up any difference, he said.
Hines said innovation box critics should move beyond skepticism based on the fact that the tax policy is simply non-traditional. He said assumptions from various commentators on the idea need to be replaced with measured statistics that target intellectual property's responsiveness to taxation.
The panel's consensus seemed to be that some compromise should inevitably be the end solution, because while one benefit an innovation box might offer could be perfected, various other dimensions would also be impacted.
To contact the reporters on this story: Aaron E. Lorenzo in Washington at email@example.com and Matthew Beddingfield in Washington at firstname.lastname@example.org
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