The relationship between corporate income tax and innovation

Abstract

The aim of the study is to investigate the correlation between Corporate Income tax (CIT) and innovation within the EU-27 countries. It delves into the question whether an increase in corporate tax impacts negatively the number of patents being applied for in the EU. To reach a conclusion for this question, this study makes use of a panel data set complied from secondary data obtained from OECD and Eurostat platforms, covering all the 27 EU member countries over the period 2000 to 2020. Factors including Real GDP, Employment rates, the European Patent Office membership and Patent Box regimes are controlled for. Utilizing a two-way fixed effects regression, the data suggests that the Combined CIT does in fact decrease the number of patent applications submitted at the EPO. This is in line with past literature findings, but the magnitude of the relationship in the EU-27 countries within this period is smaller when compared to those found in the US and in European countries in previous periods. This might be due to more importance given to R&D through the application of R&D subsidies, tax credits and economic differences throughout the years. Governments are increasingly providing R&D incentives, such as subsidies and tax credits aimed at R&D, to reduce the after-tax cost of R&D. When companies claim these tax benefits, they are more likely to allocate their funds to innovation related activities. Therefore, these incentives counteract the negative impact of higher direct CIT. External funding sources like venture capital and private equity also lessen CIT's impact on R&D spending. All of these factors reduce the tax burden on companies and make it attractive for them to engage in innovation, ultimately leading to increased patent activity. Wealthy economies are less likely to be impacted by an increase in CIT, as this additional burden would be relatively smaller when compared to economies that are worse off. It also became clear that being a member of the EPO makes applying for patents easier and thus more common. It is also evident that countries like France and the Netherlands tend to, on average, apply for more patents as they experience a lower effective tax rate. This research seeks to highlight the influence tax policies have on innovation and R&D and subsequently, economic growth.