Should 'innovation' be tax deductible?

A new report released on Monday says "innovation boxes," which allow corporations to deduct profits from patents and research activity from their taxes would allow the US to maintain its global economic footing. But such boxes can be controversial.

Giving companies a tax break on profits generated by new patents and research would help ensure that the jobs and other economic benefits they create stay in the US, according to a new report released on Monday by the Information Technology and Innovation Foundation.

The Washington-based think tank argues that Congress should adopt a so-called “innovation box,” a provision in the corporate tax code that would allow companies engaging in research to pay lower taxes on the profits generated by such activities.

In a move that would likely prove a boon to the tech industry, the group says the tax break would help the US maintain its economic competitiveness as many firms move overseas.

“Tax law should actively reward and encourage those industries that depend heavily on research and investment as well as those that face significant competition from foreign companies,” wrote Robert D. Atkinson, ITIF’s president, in the report. “The primary benefit of a well-drafted innovation box is that it encourages the kind of economic activity that strengthens the country.” [Disclosure: Mr. Atkinson writes a monthly column for the Monitor.]

Several European countries have adopted their own innovation boxes, particularly aimed at offering tax breaks to companies that hold patents and other intellectual property rights.

In the UK, for example, companies generating income from patents are offered a reduced rate of 10 percent on their taxes, compared to a 20 percent rate normally, the report notes.

Innovation boxes have received support from some members of Congress, with Reps. Charles Boustany (R) of Louisiana and Richard Neal (D) of Massachusetts introducing a proposal in July to that would let corporations deduct 71 percent of eligible profits from their taxable income.

But the idea of innovation boxes — and what types of profits should be discounted — remains controversial.

“The patent box concept is ripe for exploitation and abuse,” writes Matt Gardner, executive director at the Institute on Taxation and Economic Policy, a think tank which has advocated for closing corporate tax loopholes, in a blog post from July.

Outside influences on lawmakers could expand what types of income were covered “beyond recognition,” while corporations could quickly reclassify their own income to ensure it is covered by the tax break, he says.

For example, a 2004 effort by Congress to lower tax rates for US manufacturers expanded far beyond lawmakers’ original definition of “manufacturing,” Mr. Gardner notes.

“When the dust settled, the final law expanded the concept of 'manufacturing' to include roasting beans for coffee (an early example of the lobbying clout of Starbucks) and film and television production. When policymakers initially began discussing the manufacturing tax break, few would have imagined that the Walt Disney Company would reap more than $200 million a year in tax breaks for 'manufacturing' animated films,” he wrote, noting that even the restaurant reservation service OpenTable has benefited from the tax break.

American tech companies have particularly been criticized for setting up complex systems of shell companies and operations in countries with lower tax rates in order to avoid paying higher tax rates in the US. Recently, an advocacy group led by Nobel prize-winning economist Joseph Stiglitz began a crowdfunding campaign to raise awareness about corporate tax reform, such as widespread reports that many tech firms pay tax rates of 2 percent, and often times much less, the Washington Post reports.

ITIF’s report notes that its strong stance in favor of the boxes is not free from debate, citing two competing studies from the right-leaning Heritage Foundation and the left-leaning Center for American Progress that criticize the concept.

But Atkinson says the need for innovation boxes is particularly urgent as many companies move their research and development efforts overseas.

“The U.S. economy cannot stand to lose this global competition, especially for innovation-based industries. A well-crafted innovation box would encourage the kind of economic activity that strengthens a national economy,” he says in a statement.