Tax rates and innovation: are they as inversely correlated as some are claiming?

    Jared Bernstein Posted by Jared Bernstein.

    From 2009 to 2011, Bernstein was the Chief Economist and Economic Adviser to Vice President Joe Biden, executive director of the White House Task Force on the Middle Class, and a member of President Obama’s economic team.



    Here we have Daron Acemoglu arguing the if the US were to impose Danish level tax rates, US innovation and entrepreneurship would be significantly diminished.

    Here we have Daron Acemoglu arguing the if the US were to impose Danish level tax rates, US innovation and entrepreneurship would be significantly diminished. I ran into similar arguments a few weeks ago in comments on a paper by Gary Hufbauer about why the OECD’s initiative (called BEPS) would also stifle innovation (you can hear my comments around minute 47).

    As far as I can tell, this is all just assertion, folks. Daron’s a really interesting economist but his work on this issue tends to be theoretical, not empirical. He has a model in which cutthroat capitalist systems (that’s us) support “cuddly” systems (that’s Denmark) as our incentive structure generates innovation which the cuddly socialists then build off of.

    “…some countries will opt for a type of “cutthroat capitalism” that generates greater inequality and more innovation and will become the technology leaders, while others will free- ride on the cutthroat incentives of the leaders and choose a more “cuddly” form of capitalism. Paradoxically, those with cuddly reward structures, though poorer, may have higher welfare than cutthroat capitalists; but in the world equilibrium, it is not a best response for the cutthroat capitalists to switch to a more cuddly form of capitalism.”

    Interesting, right?

    True? Maybe not so much.

    –The Danes actually innovate pretty extensively in areas of pharmacology, wind power, shipping, and entertainment (h/t: Dean Baker).

    –My CBPP colleagues point out that there’s little evidence that tax breaks here boost entrepreneurship, whether it’s favorable treatment of investment income or R&D-style tax credits. Yes, firms that get the tax credit do research, but analysis suggests they would anyway, making this another unnecessary transfer.

    –There are a lot of low-tax countries out there. From where I sit, their main innovation seems to be selling themselves to higher tax countries as tax havens.

    –Nor is there evidence, as implied by Daron et al.’s model above, that more unequal societies are more innovative.

    –Finally, trace the history of the most notable innovations here and abroad and you’ll find the public sector, supported by tax revenue, conspicuously in on those innovations.

    In other words, this is far less black and white than these guys claim. I agree that we’re not Denmark, but I strongly suspect we could raise our tax rates to some degree here and innovation would remain robust.