Yes Indeedy, There’s A Laffer Curve For Innovation


The standard form of the Laffer Curve is simply a mathematical truth, that there are tax rates which are too low to be revenue maximising, rates which are too high to be so. Thus it is possible, dependent upon circumstances and all that, for a lower tax rate to increase tax revenues. The basic contention is only denied by those to whom it is politically inconvenient. All of the interesting discussion is around what rates, where and when?

In more detail we need to know that different taxes have different Laffer Peaks, that inversion point when raising the rate goes from revenue enhancing to gutting the tax take. In a system not a million miles from our own Scepetered Isle something like 55% tax upon incomes (so, income tax plus national insurance) is about the peak. For capital gains tax a useful analysis puts it at about 28% or so. The European Union’s own analysis of a financial transactions tax said that even a rate of 0.01% was a money loser.

Different taxes have different curves.

The difference here is how sensitive the activity is to tax rates. Given the obvious mathematical truth of the basic statement perhaps we should widen the idea. How sensitive are other things to tax rates? Say, innovation?

Taxes and innovation: shout it from the rooftops

Well, when Tyler says shout we should SHOUT of course. So, here’s the paper with this finding:

This paper studies the effect of corporate and personal taxes on innovation in the United States over the twentieth century. We use three new datasets: a panel of the universe of inventors who patent since 1920; a dataset of the employment, location and patents of firms active in R&D since 1921; and a historical state-level corporate tax database since 1900, which we link to an existing database on state-level personal income taxes. Our analysis focuses on the impact of taxes on individual inventors and firms (the micro level) and on states over time (the macro level). We propose several identification strategies, all of which yield consistent results: i) OLS with fixed effects, including inventor and state-times-year fixed effects, which make use of differences between tax brackets within a state-year cell and which absorb heterogeneity and contemporaneous changes in economic conditions; ii) an instrumental variable approach, which predicts changes in an individual or firm’s total tax rate with changes in the federal tax rate only; iii) a border county strategy, which exploits tax variation across neighboring counties in different states. We find that taxes matter for innovation: higher personal and corporate income taxes negatively affect the quantity, quality, and location of inventive activity at the macro and micro levels. At the macro level, cross-state spillovers or business-stealing from one state to another are important, but do not account for all of the effect. Agglomeration effects from local innovation clusters tend to weaken responsiveness to taxation. Corporate inventors respond more strongly to taxes than their non-corporate counterparts.

Innovation is the long term determinant of how rich we are – for it is innovation that raises productivity. For the sake of that future – for the kiddies – we should therefore be taxing as lightly as possible in order to foster that innovation. For, to put it bluntly, those who do the innovating will bugger off if we tax them too highly. And, obviously enough, at some other and higher rate they’ll not bother to do it anywhere.

So, minarchy it is then.