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Akcigit, Ufuk; Stantcheva, Stefanie

Article Taxation and

NBER Reporter

Provided in Cooperation with: National Bureau of Economic Research (NBER), Cambridge, Mass.

Suggested Citation: Akcigit, Ufuk; Stantcheva, Stefanie (2018) : Taxation and innovation, NBER Reporter, National Bureau of Economic Research (NBER), Cambridge, MA, Iss. 3, pp. 14-18

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Ufuk Akcigit and Stefanie Stantcheva

Innovation is the source of tech- financial incentives and only strive for nological progress and, ultimately, intellectual achievement. the main driver of long-run eco- Related questions are whether nomic growth. In recent work with impact the quality of innova- several co-authors, we have shown tion, where inventors decide to locate, Ufuk Akcigit is an associate pro- that the U.S. states that produced the and what firms they work for. In addi- fessor of economics with tenure at the most also grew fastest tion, there is a question of whether University of Chicago and a research over the 100-year period from 1900 taxes influence where companies allo- associate at the NBER, where he is affil- to 2000.1 We also have documented cate R&D resources and how many iated with the Productivity, Innovation, that innovation is strongly associated researchers they employ. and Entrepreneurship program. He with social mobility. U.S. regions that Answers to these questions are also is affiliated with the Centre for experienced more innovation also still lacking, and there is a scarcity of Economic Policy Research. witnessed much stronger intergenera- empirical evidence. The gap in our Akcigit’s research focuses on eco- tional and social mobility, especially understanding is especially large when nomic growth, productivity, firm dynam- when innovations were attributable it comes to the effects of policy on ics, and the economics of innovation. His to new entrant firms. Innovation also technological development over the work aims to uncover the sources of tech- correlates strongly with top income long run. nological progress and innovation that inequality, but not so much with mea- serve as engines of long-run economic sures of inequality such as the Gini or Theory and Empirics of growth. He is also interested in the role the 90/10 ratio, and is associated with Taxation and Innovation of public policy in growth, with a focus greater well-being across the United on environmental regulations, public States.2,3 There are two complementary research and funding for universities, and Given all the important conse- dimensions along which to think industrial policies such as R&D tax cred- quences of innovation, it is essen- about the interplay between taxation its and corporate taxation. tial to understand how public poli- and innovation. First, taxation on per- Some of his current papers explore cies impact innovation in the United sonal or corporate income or wealth the impact of trade and foreign compe- States and across the world. Our joint may affect innovation. This may be tition on innovation, the role of politi- research agenda explores the interplay an unwelcome byproduct of taxes cal connections in reducing innovation, between taxation and innovation. that are set for completely unrelated and the social origins and family back- Major changes in U.S. , goals, such as to raise revenues. Thus, grounds of inventors. such as those in the Tax Cuts and Jobs reduced innovation could be one of His research has been published Act of 2017, raise questions about the efficiency costs of taxation; this in leading economics journals and has whether higher taxes stifle growth, could affect the assessment of optimal been supported by the Ewing Marion productivity, and innovation. taxes, since the elasticity of innova- Kauffman Foundation, the Alfred P. If innovation, like many other eco- tion with respect to taxes would influ- Sloan Foundation, and the National nomic outcomes, is the result of inten- ence the elasticities that enter into the Science Foundation. He is the recipi- tional effort and investment, then formulas.4,5 This under- ent of a CAREER Award from the higher taxes will reduce the expected scores the importance of quantifying National Science Foundation. net return to these inputs and lead to the elasticity of innovation to taxa- Akcigit holds a BA in economics less innovation. Yet for at least some tion along all the relevant margins. from Koç University in Istanbul and path-breaking superstar inventors Second, tax policy could be designed a PhD in economics from MIT. Prior from history, such as Thomas Edison, intentionally so as not to hurt, or even to joining the University of Chicago Alexander Graham Bell, and Nikola to stimulate, innovation. in 2015, he was an assistant profes- Tesla, the picture that comes to mind Our research agenda on taxa- sor of economics at the University of is one of hard-working, enthusiastic tion and innovation seeks to under- Pennsylvania. scientists who are unconcerned with stand and quantify the effects of

14 NBER Reporter • No. 3, September 2018 taxation — of personal income, cor- the quantity of innovation, as cap- porate income, and wealth — on tured by the number of patents; the innovation by firms and individu- quality of innovation, as measured als. How do taxes shape all these by patent citations, and the share of agents’ choices leading up to innova- patents assigned to companies rather tions? Our empirical studies are based than individuals at both the state on modern-day data — European pat- level and individual-inventor level. ent office data since 1975, for exam- We also consider the location choices ple — and on long-run historical data, of firms and inventors, including such as the universe of U.S. inven- superstar inventors, as well as the cre- tors since 1836. Theoretically and ation of path-breaking, highly cited quantitatively, we study the design . of decentralized innovation policies: We employ several identification combinations of taxes, tax credits, and strategies, and find consistent results Stefanie Stantcheva is a professor subsidies that can make agents inter- across the different approaches. First, of economics at nalize the spillovers from innovations we control for state, year, and, at the and a research associate at the NBER, and foster innovation. We illustrate individual level, inventor-fixed effects, where she is affiliated with the Public our research approach by focusing on and include individual or state-level Economics and Political Economy pro- three distinct studies. time-varying controls in our specifi- grams. She is a research fellow at the cation. These go a long way toward Centre for Economic Policy Research. Taxation and Innovation absorbing unobserved heterogeneity. Stantcheva’s research focuses on the in the 20th Century In addition, we exploit tax schedule optimal design of tax systems and pub- differences across individuals within lic policies, taking into account labor Although the United States expe- a given state-year, due to tax progres- market features, complex social pref- rienced major changes in its tax code sivity, and compare individuals in dif- erences, and long-term effects such as throughout the 20th century, we cur- ferent tax brackets. Thus, we can also human capital acquisition and innova- rently do not know how these tax include state-times-year fixed effects tion by individuals and firms. Part of changes influenced innovation at to filter out other policy variations her work is centered around the study either the individual or corporate or confounding economic circum- of empirical effects of taxation of indi- level. This challenging question has stances. Second, at both the macro viduals and firms, on inequality, top largely gone unanswered because of and micro levels, we use an instru- incomes, migration, human capital, and a lack of long-run systematic data on mental variable strategy that consists innovation. innovation in the United States and of predicting the total tax burden fac- In recent work, she is exploring the the difficulty of identifying the effects ing a firm or inventor — a composite interplay between taxation and innova- of taxes. We leverage three new data- of state and federal taxes — with the tion using historical as well as modern- sets, which we constructed from his- changes in the federal tax rate only, day data and the optimal design of R&D torical data sources, to explore these holding the state taxes fixed at some policies. She is also studying how people issues.6 The datasets are a panel of the past level. This provides variation that form social preferences regarding redis- universe of U.S. inventors since 1920 is only driven by federal-level changes tribution, using large-scale online sur- and their associated patents, citations, and, thus, exogenous to any individual vey and experiment tools. and firms; a panel of all R&D labs in state. Third, we use a border county Stantcheva is the recipient of a the United States since 1921, matched strategy as a stand-alone and in com- CAREER Award from the National to their patents and with data on their bination with our instrumental vari- Science Foundation and is a Sloan research employment levels and loca- able. Finally, we study specific, sharp, Research Fellow. tions; and a historical state-level cor- tax-change episodes. She holds a BA in economics from porate and personal income tax data- We find that taxation of both the University of Cambridge, a Master’s base.7 This unique combination of corporate and personal income neg- degree in economics and finance from data allows us to systematically study atively affects the quantity, quality, Ecole Polytechnique, a Master’s in the effects of both personal and cor- and location of innovation at the economics from the Paris School of porate income taxation since 1920 on state level and the individual inven- Economics, and a PhD in economics the micro level of individual inventors tor and firm levels.8 The elasticities from MIT. She was a junior fellow at and individual firms that do R&D and of all these innovation outcomes with the Harvard Society of Fellows from on innovation at the macro state level. respect to taxes are relatively large, 2014–16, before joining the Harvard Our innovation outcomes include especially at the macro level, where faculty in 2016.

NBER Reporter • No. 3, September 2018 15 cross-state spillovers and extensive margin responses add to the micro U.S. State Marginal Tax Rate and Patent Production elasticities. Figure 1 illustrates the negative correlation between the per- Log patents sonal income tax at the 90th income 0.2 percentile and the log of patents in a state. 0.1 We also find that corporate inven- tors are more elastic with respect to 0 personal and corporate income tax- ation than non-corporate inventors. Agglomeration effects appear to mat- -0.1 ter as well: Inventors are less sensitive to taxation in places where there is -0.2 already more innovation done in their technological field. -0.3 -4 -2 0 2 4 The International Mobility 90th percentile-earner personal-income marginal tax rate (%) of Superstar Inventors in Both patents and tax rates are reported net of control variables Response to Taxation Source: U. Akcigit, J. Grigsby, T. Nicholas, and S. Stantcheva, NBER Working paper No. 24982 There is a long-standing debate about whether higher top tax rates Figure 1 will cause a “brain drain” of high- one major challenge that arises when quality are comparable enough to be income and high-skill economic studying migration responses to taxes, similarly affected by country-year level agents. In fact, many of the great namely, to model the counterfactual policies and economic developments; inventors were international immi- payoff that an inventor would get in but only those inventors in the top grants: Alexander Graham Bell, inven- each potential location, thanks to a set bracket are directly affected by top tor of the telephone and founder of of detailed controls that come from taxes. Hence, the lower-quality top the Bell Telephone Company; James the patent data, most notably, mea- 5–10 percent, top 10–25 percent, and Kraft, inventor of a pasteurization sures of an inventor’s quality based on below top 25 percent groups serve as technique and founder of Kraft Foods; past citations. control groups for the top 1 percent and Ralph Baer, creator of a TV gam- Our measure of the effects of the group. ing unit that launched the video game top tax rate filters out all country-year Figure 2 provides some prelimi- industry, are examples. level variation and exploits the differ- nary visual evidence of the effects of Inventors are frequently more ential impacts of the top tax rate on taxes. It shows how the number of mobile than other high-skill individu- inventors at different points in the superstar top 1 percent foreign inven- als, and they carry and transmit their income distribution within a country- tors in the U.S. increased after the Tax valuable knowledge and expertise to year cell. To implement this strategy, Reform Act of 1986 relative to a coun- others, which makes them important we define superstar inventors as those terfactual path estimated from a syn- for both new knowledge creation and in the top 1 percent of the quality dis- thetic control country. for its diffusion. Yet little is known tribution, and similarly construct the Overall, we find that superstar about the international mobility of top 1–5 percent, the top 5–10 per- inventors’ location choices are signif- labor in response to taxation. Rigorous cent, and subsequent quality brack- icantly affected by top tax rates. The evidence is lacking because of a scar- ets. We know from other research that elasticity to the net-of-tax rate of the city of international panel data. inventor quality is strongly correlated number of domestic superstar inven- We use a unique type of interna- with income and that top 1 percent tors is around 0.03, while that of for- tional panel data on inventors from the inventors rank very high in the top tax eign superstar inventors is around 1. European and U.S. patent offices and bracket. The probability of being in These elasticities are larger for inven- from the Patent Cooperation Treaty the top bracket and the fraction of an tors who work for multinational com- to study the international migration inventor’s income in the top bracket panies. Inventors are less sensitive to responses of superstar inventors to declines as one moves down the qual- taxes in a country if their company top income tax rates for the period ity distribution. Top 1 percent inven- performs a higher share of its research of 1977–2003.9 We are able to tackle tors and those of somewhat lower there, suggesting that the location

16 NBER Reporter • No. 3, September 2018 decision is influenced by the com- cult to predict a firm’s innovation suc- tion spillovers and the correction for pany and by career concerns that may cess, even based on many observables. the monopoly power induced by the dampen the effects of taxes. The government would like to encour- intellectual property rights system that age the best firms, but policies have to emerges from the method of distin- R&D Policy Design work despite the asymmetric informa- guishing good firms from bad ones. tion and unobservable inputs, and need The more complementary observable Countries enact many different, to distinguish productive firms from R&D investment is to firm research often very costly policies designed to less productive ones. productivity, as opposed to being com- foster research and development by To solve this problem, we build on plementary to the unobservable R&D firms. These are motivated by the view new dynamic mechanism design meth- effort, the more rents a firm can extract that there is underinvestment in R&D ods developed in several recent papers if R&D investment is subsidized. This because of the non-internalized spill- and offer a new approach to allow puts a brake on how well the govern- overs that the innovations of one firm for spillovers between agents (here, ment can correct for spillovers and can have on other firms and, ultimately, firms) with asymmetric information.11 monopoly distortions. On the other on society. Yet, there is no consensus on We then estimate the model and use hand, if R&D investments are more how such policies should be designed. it to simulate a range of policies for complementary to unobservable firm We therefore study the joint design firms of different ages, sizes, and pro- R&D effort, the optimal R&D sub- of R&D policies and corporate taxa- ductivities. We use U.S. Patent and sidy will be greater because subsidizing tion.10 The key new elements in our Trademark Office patent data matched the observed input will lead the firm to analysis are the assumptions that firms to Compustat data on publicly traded put in more of the unobservable input are heterogeneous in their ability to firms, as well as the Longitudinal as well. produce innovations, and that this abil- Business Database (LBD) for all firms. The policies that efficiently trade ity is known to the firm, but not to the This allows us to see the observable off these considerations are different government. In addition, while some inputs to innovation, that is, a firm’s from current policies as well as sim- of the inputs into the R&D process are R&D expenses, as well as the outputs of pler policies, such as linear R&D sub- observable (R&D investment), others innovation as captured by the patents sidies and taxes. Nonlinear policies, are unobservable (R&D effort). The and their citations. such as an R&D subsidy that depends returns to these inputs are also stochas- We show that the need to screen on the amount of R&D investment and tic, which makes innovation risky. firms can starkly influence the shape a profit tax that depends on the level These ingredients capture some of of R&D policies and firm taxation. of profits, can come closer to the con- the very real constraints facing policy- The central policy tradeoff is between strained-efficient outcome. makers. For instance, it is very diffi- the Pigouvian correction for innova- Our findings suggest that taxes significantly affect innovation and that they can thus have far-reaching The 1986 Tax Reform Act and Foreign Superstar Inventors in the U.S. consequences on technological prog- ress and growth. If designed properly, Share of foreign superstar inventors in the U.S., normalized to 1 in 1986 the tax system could help foster inno- 2.5 vation by better aligning the incen- Tax reform takes e ect Actual tives of private agents with the social value of innovation. 2 1 U. Akcigit, J. Grigsby, and T. Nicholas, 1.5 “The Rise of American Ingenuity: Innovation and Inventors of the Golden Estimate based on control (synthetic) country Age,” NBER Working Paper No. 23047, 1 January 2017. Return to Text 2 0.5 P. Aghion, U. Akcigit, A. Bergeaud, R. 1982 1984 1986 1988 1990 1992 Blundell, and D. Hémous, “Innovation and Top Income Inequality,” NBER Working Paper No. 21247, June 2015, Source: U. Akcigit, S. Baslandze, and S. Stantcheva, NBER Working Paper No. 21024 and forthcoming in The Review of Economic Studies. Figure 2 Return to Text

NBER Reporter • No. 3, September 2018 17 3 P. Aghion, U. Akcigit, A. Deaton, Paper No. 24466, March 2018. 10 U. Akcigit, D. Hanley, and S. and A. Roulet, “Creative Destruction Return to Text Stantcheva, “Optimal Taxation and and Subjective Well-Being,” NBER 7 The authors constructed the corpo- R&D Policies,” NBER Working Paper Working Paper No. 21069, April 2015, rate tax database; the personal income No. 22908, December 2016. and the American Economic Review, tax database was constructed by Jon Return to Text 106(12), 2016, pp. 3869–97. Bakija. [J. Bakija, “Documentation 11 A. Pavan, I. Segal, and J. Toikka, Return to Text for a Comprehensive Historical U.S. “Dynamic Mechanism Design: A 4 E. Saez, “Using Elasticities To Drive Federal and State Income Tax Calculator Myersonian Approach,” Econometrica, Optimal Income Tax Rates,” NBER Program,” Williams College Working 82(2), 2014, pp. 601–53; S. Working Paper No. 7628, March 2000, Paper, 2008.] Stantcheva, “Optimal Taxation and and The Review of Economic Studies, Return to Text Human Capital Policies over the Life 68(1), 2001, pp. 205–29. 8 U. Akcigit, J. Grigsby, T. Nicholas, and Cycle,” NBER Working Paper No. Return to Text S. Stantcheva, “Taxation and Innovation 21207, May 2015, and the Journal of 5 E. Saez and S. Stantcheva, “A in the 20th Century,” NBER Working Political Economy, 125(6), 2017, pp. Simpler Theory of Optimal Capital Paper No. 24982, September 2018. 1931–90; S. Stantcheva, “Learning Taxation,” NBER Working Paper Return to Text and (or) Doing: Human Capital No. 22664, September 2016, and the 9 U. Akcigit, S. Baslandze, and Investments and Optimal Taxation,” Journal of , 162, S. Stantcheva,“Taxation and the NBER Working Paper No. 21381, 2018, pp. 120–42. International Migration of Inventors,” July 2015; S. Stantcheva, “Optimal Return to Text NBER Working Paper No. 21024, Income, Education, and Bequest 6 U. Akcigit, S. Caicedo, E. Miguelez, March 2015, and the American Taxes in an Intergenerational Model,” S. Stantcheva, and V. Sterzi , Economic Review, 106(10), 2016, pp. NBER Working Paper No. 21177, “Dancing with the Stars: Innovation 2930–81. May 2015. through Interactions,” NBER Working Return to Text Return to Text

18 NBER Reporter • No. 3, September 2018