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Higher taxes mean less innovation

On Tuesday, I wrote about how Minnesota has lagged the nation on Research & Development (R&D) spending since 2012. Data from the National Science Foundation shows that, as a share of state GDP, our state spent less on R&D than the nation generally between 2012 and 2015 (the most recent year for which there is data).

Why might this be? That is a question economists Ufuk Akcigit and Stefanie Stantcheva recently examined for the National Bureau of Economic Research.

If innovation, like many other economic outcomes, is the result of intentional effort and investment, then higher taxes will reduce the expected net return to these inputs and lead to less innovation. Yet for at least some path-breaking superstar inventors from history, such as Thomas Edison, Alexander Graham Bell, and Nikola Tesla, the picture that comes to mind is one of hard-working, enthusiastic scientists who are unconcerned with financial incentives and only strive for intellectual achievement. 

Is innovation affected by tax rates? Akcigit and Stantcheva find that

…taxation of both corporate and personal income negatively affects the quantity, quality, and location of innovation at the state level and the individual inventor and firm levels. The elasticities of all these innovation outcomes with respect to taxes are relatively large [meaning that innovation is very sensitive to tax rates], especially at the macro level, where cross-state spillovers and extensive margin responses add to the micro elasticities. Figure 1 illustrates the negative correlation between the personal income tax at the 90th income percentile and the log of patents in a state.

Figure1
We also find that corporate inventors are more elastic with respect to personal and corporate income taxation than non-corporate inventors. Agglomeration effects appear to matter as well: Inventors are less sensitive to taxation in places where there is already more innovation done in their technological field. 

Taxes are negative incentives; if you tax some activity more you get less of that activity, ceteris paribus. Minnesota is a high tax state. As we explain in our recent report The State of Minnesota’s Economy: 2018, our top rate of income tax is higher than in all but three states and our lowest tax rate is higher than the highest rate in 23 states; we have the third highest rate of corporate tax in the U.S. Akcigit and Stantcheva’s research gives us a plausible candidate for Minnesota’s R&D gap.

John Phelan is an economist at the Center of the American Experiment. 

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