A Tax Plan for Endogenous Innovation
45 Pages Posted: 23 Aug 2018 Last revised: 15 May 2019
Date Written: 2017-11-01
In times when elevated government debt raises concerns about dimmer global growth prospects, we ask: How can the government provide incentives for innovation in a fiscally sustainable way? We address this question by examining the Ramsey problem of finding optimal tax and subsidy schemes in a model in which growth is endogenously sustained by risky innovation. We characterize the shadow value of growth and entry in the innovation sector. We find that a profit tax is required to replicate the first-best in order to balance the externalities associated with innovative activity. At the second-best, the profit tax is designed to optimally respond to growth shocks above and beyond what is prescribed by the standard tax-smoothing incentives in economies with exogenous growth. The interplay of risk and innovation opens a new margin for optimal taxation.
Keywords: innovation, R&D investment, endogenous growth, government debt, labor tax, subsidy, profit tax
JEL Classification: E32, E62, H21, H63, O3
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