The effects of taxation on entrepreneurship and innovation

Innovation and entrepreneurship play a pivotal role in sustained
U.S. economic growth and improved standards of living through
lower prices, higher wages, and advances in healthcare. There
are many factors involved in bringing an idea to the market, but
we know surprisingly little about the role of government, and
taxation specifically, in attracting foreign entrepreneurs and
spurring or repressing U.S. innovation. Stefanie Stantcheva, an
Equitable Growth grantee and Junior Fellow at the Harvard
Society of Fellows (and future assistant professor at Harvard’s
Department of Economics), together with co-authors Ufuk Akcigit
an Assistant Professor at the University of Pennsylvania and
Salome Baslandze, a Graduate Student at the University of
Pennsylvania, seeks to understand how tax systems affect
international mobility and the activity of innovators and
entrepreneurs.
To do so, Stantcheva will combine international data on inventors
and their patents, and tax policies across developed economies
in order to understand how income taxes, a country’s
immigration policies, and companies influences the activity and
mobility of inventors as well as the quality of innovative activity.
The focus is on “superstar’’ inventors, those inventors with the
most and most valuable patents, who play a key role in
economic growth. She will use the results to build a more
complete taxation model, which takes entrepreneurship and
innovation into account.
Stantcheva posits that a progressive tax code can reduce the
profits from any given innovation, thus encouraging inventors
and entrepreneurs to move to a lower-tax country. Her
preliminary results find that, broadly speaking, this prediction
holds true. Yet she also finds these results can be mitigated by a
country’s investment in a strong basic research infrastructure,
allowing for an active community of innovators whose
contributions to growth are shared equally instead of just among
the top earners.
Stantcheva suggests that progressive tax systems may also
safeguard against the high possibility of failure inherent to any
start up, allowing smart individuals without an abundance of
wealth to act on their good ideas. Her hypothesis is supported
by some emerging literature , which contends that some
government social insurance programs can actually spur
entrepreneurship by encouraging people to take risks.
Her final results, due out later this year, will be timely for U.S.
policymakers, many of whom are under pressure to cut U.S.
research & development funding. To the untrained eye, spending
millions of dollars on, for example, fruit fly research may seem
wasteful. In fact, this research not only serves as the basis for
understanding the entire human genome and many genetic
diseases but also produced massive economic returns relative to
the original public investment. Despite such evidence, R&D
spending by the federal government as a percent of GDP has
dropped from 1.7 percent in the 1970s, to 0.7 percent in the
2000s, a phenomenon that may, in the long run, reduce the long-
term growth of our economy.
Furthermore, with foreigners comprising 40 percent of all
science and engineering Ph.D. graduates in the United States—
many of whom are not permitted to stay because of our current
immigration laws—there is ample reason to consider reforms to
these laws in order to attract and retain more of the talent that
creates jobs and drives our economic prosperity. Congress is
beginning to take notice, with the recent introduction of the
bipartisan Startup Act , which would create a new “entrepreneur”
visa category for foreign students who graduate in STEM fields.
Too little is known about how taxes interact with innovation and
entrepreneurship, despite invention being a cornerstone of
growth. Many immediately conclude that a progressive tax
system reduces the returns to innovation, and thus discourages
entrepreneurship, which intuitively makes sense. Stantcheva’s
research, however, allows us to consider whether this
assumption is just one of many considerations we must take into
account when designing optimal tax systems and policies to
boost innovation and spur economic growth.