The Case Against Tax Subsidies in Innovation Policy
48 Pages Posted: 27 Jul 2020 Last revised: 12 Aug 2022
Date Written: March 31, 2020
Until recently, intellectual property (IP) scholars agreed that patents were the prime innovation tool to aggregate decentralized information. This case for the property approach, which argues patents
are appropriate when information about possible inventions and the social value of inventions are hidden, is now also under pressure in the literature. IP scholars argue that tax subsidies for firms that invest in research and development (R&D) replicate many of the merits of the patent system under conditions of asymmetric information.
Based on developments in institutional economics, this Article shows that tax subsidies are not market-set incentives and are not optimal tools for aggregating decentralized information. Tax subsidies target specific investments ex-ante in relation to the market process when there is little information on the costs of specific projects or their social value. Governments lack the knowledge required to decide which projects to support and to calibrate the subsidies according to their social value. Comparatively, a patent system is better equipped for the decentralized nature of information. Moreover, it relies on entrepreneurs and inventors to decide which new projects to pursue and on consumers within the marketplace to evaluate the value of these innovations. Based on public choice theory, the Article also argues tax subsidies for innovation are particularly vulnerable to rent-seeking, leading tax dollars to be captured by the politically powerful—not by
disruptive newcomers. From an institutional perspective, a more sensible innovation policy lies in simplifying, stabilizing, and generalizing the rules of property and contract that set the market
process in motion.
This is therefore the first article, amid growing scholarly consensus concerning subsidies as the new innovation tool, to present both a full-blown critique and a radical alternative. In contrast to contemporary innovation scholarship, which is often animated by presumptions of perfect information and benevolent policymakers, this Article demonstrates the superiority of the property approach under imperfect conditions.
Keywords: Research and Development Tax Credit, Intellectual Property (Ip), Tax Subsidies, Innovation Policy
JEL Classification: K00, K34
Suggested Citation: Suggested Citation