In recent years, the United States has become less competitive in retaining and attracting globally mobile capital. That’s in large part due to an uncompetitive tax code that features the highest statutory corporate tax rate among OECD countries; a worldwide, as opposed to territorial, tax system; and an intermittent research and development (R&D) tax credit that has fallen to just the world’s 27th most generous, behind even Brazil, China, and India.
It’s high time for Congress to begin a serious reexamination of U.S. tax policy and to incorporate innovative approaches that spur greater levels of R&D, innovation, and investment by enterprises operating in the United States. One proposal that ITIF has long championed is the “innovation box” (or “patent box”). So named because it is implemented through a check box on a tax form, the policy provides favorable tax treatment for revenues generated from newly developed intellectual property (IP). As ITIF explained in its 2011 report “Patent Boxes: Innovation in Tax Policy and Tax Policy for Innovation,” these provisions differ from—and should be seen as a supplement to—R&D tax credits in that they provide firms with an incentive to commercialize innovation, rather than just conduct research. Today, more than a dozen countries—including Belgium, China, France, Spain, and Switzerland—have introduced patent boxes that tax qualifying profits at a lower rate in order to incentivize innovation. And as ITIF notes in “Ten FAQs About Patent Boxes,” studies have found that nations offering patent box policies do succeed in inducing firms to patent more.
That is why it is encouraging that U.S. Reps. Charles Boustany Jr. (R-LA) and Richard Neal (D-MA) this week put forward a discussion draft of bipartisan legislation to do just this. The Innovation Promotion Act of 2015 would create an “innovation box” allowing companies to claim an effective 10.15 percent tax rate for income derived from a wide range of qualifying intellectual property, including patents, inventions, formulas, processes, and designs and patterns, as well as other types of IP, such as copyrighted computer software.
Companies would be allowed to deduct 71 percent of their “innovation box” profits derived from qualifying IP, with the 71-percent deduction translating to an effective tax rate of 10.15 percent. The proposed legislation defines innovation box profits as equal to tentative innovation profit multiplied by the corporation’s R&D ratio, where the R&D ratio equals the company’s domestic R&D expenditures over the preceding five years divided by the corporation’s total costs over the preceding five years. The draft legislation also seeks to entice companies to bring IP held by their foreign subsidiaries back to the United States by exempting such transactions from taxes.
These provisions not only create a stronger incentive to conduct R&D in the United States (something that has been lagging in recent years as U.S. corporate R&D has grown 2.7 times faster overseas than has all corporate R&D in the United States), they also mean a lower effective tax rate on innovation-based industries, the ones that are most subject to global competition.
ITIF commends Reps. Boustany and Neal for their leadership in bringing the innovation box concept to the table as part of broader comprehensive tax reform: There is much to like in the proposal. However, one element that could be added to strengthen the legislation is language that grounds the preferred tax rate partly on the extent to which corresponding production is conducted domestically. This would provide firms with a much stronger incentive to innovate and produce in the United States.
As ITIF has noted, the U.S. innovation box wouldn’t be the world’s first; but it could be the world’s best. By tying together R&D, high-tech manufacturing, and commercialization of U.S. IP, a well-formulated innovation box would create a powerful incentive for firms to develop and produce innovation within the United States.