Intellectual property scholars have vigorously debated the merits of patents versus prizes for encouraging innovation, with occasional consideration of government grants. But these are not the only options. Perhaps most significantly, the patents-vs.-prizes (or patents-vs.-prizes-vs.-grants) debate has largely neglected the role of tax incentives in innovation policy, despite the tens of billions of dollars spent globally on tax breaks for R&D activities each year. How should R&D-related tax incentives figure into this debate, and what criteria are relevant for policymakers selecting among the various tools?
In this Article, we develop a new taxonomy of innovation policies that allows direct comparisons among patents, prizes, grants, and tax incentives. This taxonomy highlights the overlooked benefits of tax credits: like patents, they elicit privately held information about the expected value of R&D projects; like grants, they reduce the social-welfare costs of frictions in imperfect capital markets. Our taxonomy also sheds light on new non-efficiency dimensions of R&D policy. Grants and tax credits distribute rewards among innovators in a more egalitarian manner than patents and prizes (without necessarily sacrificing efficiency). And incentive mechanisms also differ in their distribution of costs among users: grants, tax credits, and prizes generally require all taxpayers to subsidize R&D regardless of whether they use the resulting products, whereas the patent system imposes R&D costs primarily upon the consumers who purchase patented products.
Ultimately, optimal innovation policy will depend on a range of factors, including the government’s ability to evaluate projects, innovators’ capital constraints and risk aversion, the relative deadweight loss of taxation and that of patents, administrative costs, and considerations of distributive justice. Because almost all of these factors point to more than one of the four main incentivizing mechanisms, innovation debates should not truncate the menu of policy options to only two or three of these tools.
Our analysis also highlights the tax-like characteristics of patents: a patent operates in much the same way as a sales tax levied on a narrow tax base. But unlike other taxes, the patent system’s costs are not reflected in the federal budget, making patents seem like the cheapest innovation policy option regardless of their actual cost. To neutralize this political-economy advantage, we propose that estimates of the patent system’s “shadow” sales tax on patented goods be incorporated into total tax calculations, and that the “shadow” prize to patentees be incorporated into estimates of long-run expenditures.