Innovation Boxes On Fast Track For Tax Reform

Amid the ongoing Greek financial crisis, the New York Stock Exchange glitch, and a stock crash in China, many missed a key economic development from last week: the inclusion of a promising new tax policy in a white paper from [mc_name name=’Sen. Rob Portman (R-OH)’ chamber=’senate’ mcid=’P000449′ ].

In the final report from an ad-hoc working group he helped establish to lay the groundwork for key tax reforms, [mc_name name=’Sen. Rob Portman (R-OH)’ chamber=’senate’ mcid=’P000449′ ] (R-OH) embraced a policy known as “innovation boxes,” which would create a reduced tax rate for profit from patents, trade secrets and other inventions.

The policy, already adopted widely in Europe, is crucial to keeping the U.S. economy competitive in the global tax arms race and would create an economic incentive for just the types of creative ingenuity that improves all of our lives.

Politically, its adoption in the Portman plan is especially important because House Ways and Means Chairman [mc_name name=”Rep. Paul Ryan (R-WI)” chamber=”house” mcid=”R000570″ ] quickly expressed his support. Ryan, given his powerful committee perch and position as an intellectual leader of the GOP, is arguably the single most important actor on tax reform in the next several years.

Other key lawmakers in Congress from both parties have expressed past support as well, and it’s easy to see why.

First, the policy makes sense on its face as a means of what Abraham Lincoln, speaking about the patent system, described as adding the “fuel of interest to the fire of genius.” While all economic growth is desirable, it’s the new breakthroughs that really create progress, resulting in better things at lower prices in the long term.

And unlike many tax incentives, innovation boxes aren’t targeted at a specific sector or even company. They don’t pick “winners and losers” and suffer when economic conditions change. The reason tax reform is needed in general is because the current tax code is littered with a patchwork of old carve-outs that have long outlived their usefulness, but stay in place because of a continuing political constituency.

Just think about World War II-era mohair subsidies, for instance. They were instituted in 1949 because military uniforms were made of wool. Over sixty years later, they continue apace despite the purported need for the subsidies having expired decades ago.

But unlike tax incentives for specific industries, there is no horizon on the value of invention. The creation of new intellectual property is inherently good.

The second major reason why the policy is so important is because of tax competition. With other nations adopting their own versions of innovation boxes, often called “patent boxes,” many companies are finding it is often cheaper to locate their most valuable goods overseas.

This is particularly so because intellectual property – unlike tangible factories and other things that make up a business – only exist as an idea, so can be “moved” to another jurisdiction relatively effortlessly.

In his white paper, Portman recounts the story of Salix Pharmaceuticals, a North Carolina firm. With the U.S. tax-code increasingly uncompetitive with other nations, Salix considered “inverting” to Ireland, only to call off the move given the uncertainty of SEC regulations. Instead, foreign firms began a bidding war to purchase Salix, which was ultimately sold to a former-U.S. company that had inverted to Canada.

We can’t have a tax system that makes it far cheaper for our most valuable companies to be purchased by foreign companies, and tax reform needs to address counterproductive incentive structures like this.

Innovation boxes are a great step in the right direction, and ultimately could help spur economic growth – and great, high-paying jobs – here in the U.S.

Portman and Ryan ought to be commended for backing it.


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