Spurring innovation

This is a critical election year for the UK and the United States. The economies of both countries have fallen under a spotlight, with particular emphasis on the efficiency and revenue potential of taxation systems.

While many will agree that taxation is a great public good, many also wonder at how tax systems might be improved as services and infrastructure seemingly deteriorate and the richest in society are accused of getting off lightly.

Taxation, Innovation and Productivity

"The quiver of economic policies feels very empty," says London Business School's Dr Joseba Martinez, reflecting on the need to reform and innovate tax systems. He was speaking on Sirius XM's Business Briefing programme, discussing his working paper, Taxes, Innovation, and Productivity with Business Briefing's host, Janet Alvarez.

In the paper, which examines tax changes in the United States over the post-WW II period, Dr Martinez and his co-authors, LBS Professor Paolo Surico, James Cloyne, and Haroon Mumtaz, find that temporary cuts in corporate income tax rates lead to a long-lasting increase in innovation and productivity. By contrast, changes in personal income tax rates only have short-term effects.

Cutting corporate income tax can, observes Martinez, be an extremely blunt instrument approach because society needs the revenue, and as nations and communities we care about fairness. Many people think that corporations pay too little tax and that may well be right. However, what we need to design is a taxation system that does not discourage investment, particularly in areas of the economy that spark innovation.

Supporting innovation

Martinez and his co-authors hold that innovation is the principal means to underpin higher standards of living and that better devised tax policies will spur invention and concomitantly generate wealth. An illustration of Martinez and his co-authors' investigation into this area is a company that creates a new patent but lacks the resources to secure a new export market for the innovative product or service. Another firm proves that it possesses the means to turn this new idea into a significant export earner and it is this company that should be allowed to purchase the patent and not be penalised by the taxation system for doing so. "The ultimate aim is to create a new market opportunity that generates significant wealth," says Martinez.

"Today’s tax system does not favour this trade in ideas between firms, it discourages it. Firms should be able to deduct from their profits costs associated with innovation and not have these instruments and mechanisms of innovation taxed."

To listen to the full discussion between Dr Martinez and SiriusXM's Janet Alvarez, click here