The House Ways and Means Committee thinks a "patent box" may be the answer to solving corporate tax inversions. Unfortunately, it looks more likely that, if enacted, the legislation might just be another complication in a tax code already filled with headaches.
In an attempt to prevent corporations from moving highly-valuable intellectual property to lower tax jurisdictions, governments are trying to find ways to keep corporates happy, most notably, in the form of tax breaks. The patent box is one of these proposals.
The latest proposal introduced to Congress would create an exemption for income derived from a company's intellectual property (such as patents), and tax it at a substantially lower rate than other income.
Unfortunately, as you might imagine, determining what would qualify under the patent box tax exemption creates a host of issues. Among them, many critics say that it wouldn't solve the avoidance problem; in fact it will just exacerbate it.
One of these critics is Jason J. Fichtner, a senior research fellow at the Mercatus Center at George Mason University. His research focuses on Social Security, federal tax policy, federal budget policy, retirement security, and policy proposals to increase saving and investment. We sat down to discuss a potential patent box in the U.S., and he told me that corporations would certainly find a way to make this deduction work for them.
"People respond to incentives, and corporations are run by people. If we do some kind of patent box as it has been described, we will see business try to re-label their business activities as a patent or innovation," Fichtner explained.
"Say you go to Starbucks and buy a coffee," he continued. "What do you think the actual materials cost to make that coffee? Not much, right? So what you're going to have are businesses claiming that outside of raw materials, everything else is attributable to technology and innovation, and thus, can be exempted under a patent box. All you're going to do is create a big incentive for lawyers and accounts and economists to find something that can be attributable to innovation."
Sounds like the same old tale, and there's a reason for that. Fichtner says the tax code is woefully outdated, and trying to enact a patent box, or any similar tax breaks, without massive overhaul is akin to putting a bandage on a bullet hole.
"The United States is a 21st century economy with a 1945 tax code. We have a tax code that was fundamentally conceived when we were the only super power in the world, and we were helping the world rebuild after World War II," he explained. "If you were an immigrant, you wanted to come here. But as times have changed, thanks to the digitization of commerce, it just isn't necessarily the case anymore. And as a result, we need to have an honest discussion about what it means to have a tax system to be outdated, and what does a tax system that's modernized looks like."
That's not to say a patent box can't work under the right circumstances. The United Kingdom implemented one as part of its 2012 Finance Act, and studies have found that--as of October 2015--639 companies have benefited to the tune of a total of 335 million as a result. In turn, corporations have made "large investments into the U.K. being attributed to the existence of the patent box", according to the consultation document from the U.K. government. Fichtner himself says that the U.K. model has been effective, but he believes there's a better way for the U.S.
Fichtner, who admittedly refers to himself as a "free market economist who believes the ideal corporate tax rate is zero," says that the only way to get back the tax revenue the U.S. is losing overseas is to make it more attractive to do business here, and the patent box pales in comparison to lowering the corporate tax rate. So what should be the U.S.'s goal when it comes to a new corporate tax threshold?
"I think it's around 25 percent. That would knock a third off the existing 35 percent rate, and if we keep our current deductions, the rate would be lower than that 25 percent, all while putting us at-or-near the Organisation for Economic Co-operation and Development (OECD) average," he said. "But we're losing the rate war. Do we want to step out and get in front of the curve to be more competitive, and go lower than 25 percent? We should think about it, because if we keep trying to get into a rate war, we're not going to win it based on how long it takes us to react."