To encourage production of new terrain, a tax subsidy for maps


This is a post about a paper I just put out to Elsevier’s SSRN, because I believe every academic paper should have a blog post explaining why it is useful.

The paper is about the intellectual property (IP) box. The proposal is to provide a lower tax rate to profits associated with a patent or other IP. IP boxes currently exist in a few countries, and a few bills have been introduced in the U.S. Congress to set up an IP box.

The bills proposing IP boxes—which they refer to as innovation boxes—could possibly be traced to a measurement problem. Innovation is hard to define, let alone measure, so many academics will use patent rates as a proxy, in a classic case of looking under the lamppost and replacing a complex concept with something that can be counted and looked up in a database. This seems to have become ingrained, and arguments about patent boxes seem to depend upon the assumption that patents==innovation. This column traces where that substitution leads us.

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The problem of incentivizing nothing

Maybe this will sound obvious, but it is impossible to offer a tax credit on money nobody spends. This basic fact creates noticeable distortions in the landscape of the tax code.

Say that the Planning Committee has determined that sugary drinks are bad for you. One approach (`the stick’) is to tax drinks with high sugar content. One (`the carrot’) is to give a tax credit or subsidy for buying drinks that substitute away from sugary drinks, like low-calorie soda or carrot juice.

Setting aside Tang,  sugary drinks do not live in a vacuum. Perhaps last year the Planning Committee initiated another set of tax subsidies to handle malnourishment, and recognizing that carbohydrates are a necessary nutrient and that sugar is a pure form of carbohydrate, set up a tax subsidy for sugar.

At the end of it all, the only people not getting some sort of tax subsidy are the people who don’t buy drinks. If you’re drinking tap water, buying two boxes of tea a year and calling that your beverage budget, growing carrots and juicing them yourself, then you are outside of the economy, and there’s no way for a tax subsidy to reach you.

To give another example, my local electric company will pay a not-negligible subsidy to people who agree to install a smart thermostat that slows down their air conditioner during peak demand periods. Except I’m ineligible, because my house doesn’t have an air conditioning unit at all. It may be cost-effective for me to install a cheap unit I never use so I can score the subsidy.

In those situations where there is a `sinful’ form of consumption, the first best outcome is to simply not consume, but not consuming can’t receive a subsidy. The second best is lite consumption, and this is where the tax code is able to nudge people.

Last time, I went over some of the more interesting credits on Form 3800 (PDF), but the bulk of the credits are energy-related:

1f renewable electricity, refined coal, Indian coal production
1l biodiesel, renewable diesel
1m low sulfur diesel
1o nonconventional source fuel
1p energy efficient home
1q energy efficient appliances
1r alternative motor vehicle
1s Alternative fuel vehicle refueling property
1y Qualified plug-in electric drive motor vehicle
4c Biofuel producer
4e Renewable electricity, refined coal, and Indian coal production again

There are a lot of fuel taxes (Form 720), but use Form 4136 to get a zero tax rate for certain uses of gasoline, undyed diesel, undyed kerosene, kerosene used in aviation, liquefied petroleum gas, compressed natural gas, liquefied hydrogen, Fischer-Tropsch process liquid fuel from coal (including peat), liquified fuel or gas from biomass, liquified natural gas, and diesel-water fuel emulsion blending.

And lest you worry that only the petroleum alternatives are getting the credits, I enjoyed this overview of the subsidies that oil extraction companies receive (PDF).

At this point, it is hard to imagine a U.S. motor whose operation is not somehow subsidized by the federal government.

Of course, if you run a fleet of bike taxis in San Diego, where the weather is always so perfect that your office needs neither a/c or heating fuel, there are no credits for you.

In total, the incentives on Form 3800 are consistent with the story I told above: you can’t incentivize doing nothing, but you can incentivize consumption lite, like buying efficient appliances and renewable diesel. More on reading these incentives next time.

The commune

An alternative hypothesis is that the goal of the code is not to shape society for some undefined better, but to push its members to move.

In a world where the only businesses are wholly self-sustaining yogic meditation communes, where everybody drinks juices made from fruits and veggies in the garden and they burn the cow’s manure on chilly nights, no money is exchanged and so GDP is zero. If your goal is maximum GDP growth and all you have are people who are blissfully self-sustaining, you have to find a way to get people to move. To modify a standard example, if you can get the people in commune A to water the plants in commune B for $10,000/year, and get the people in commune B to water the plants in commune A for $10,000/year, then the commune members are doing no additional work besides walking next door, but GDP is up $20,000/year (and tax rates follow accordingly).

My commune example may sound far-fetched, but more and more of the economy is about information, which is relatively costless to move, using open source or free-to-use software. The person who runs Pinboard broke down what he pays to run the web site that is his livelihood. He pays for four Amps a month. Doing some back-of-the-envelope math, four Amps at 110 volts for a month comes out to 317 kWh. For reference, my household of four people used 185 kWh last month, so this person’s entire business uses as much energy as two residential households. He’s not running a commune off the grid, but just about any business based on moving physical objects or maintaining a storefront or sending people around on frequent flights will show a greater mark on the GDP accounts.

By this reading, the basic message of the tax code is not that you should use energy efficiently, but that you should use energy. Form 3800 is consistent with this story as well.

Fun with Form 3800

This is part of a series on Form 3800. I started with this piece about how much the public can or should learn about obscure details of law, followed by this piece about laws that divide the population between people who directly benefit from the credit and people who have never heard of the credit. This section provides examples of such laws, diving into Form 3800 (PDF) itself.

The first two pages Form 3800, General Business Credits, are largely an equation stretched out over two pages, because IRS assumes that everybody does their taxes with an abacus. Skip to Part III on page three, which is the list of tax subsidies.

Each line is its own story. If I had a class of 36 or fewer students, I’d give each student one line to dig into.

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Why failing startups that do stupid things get bought for millions

Year zero. Your hip new startup—it’s like Uber, but for trees—just got off the ground, and lost a million dollars. On the plus side, it had no taxes. Year one: it took off, and made three million bucks. Your company is allowed to carry over the losses from the prior year, so that the reported taxable profits in the second year are only two million. This story of a company that loses in its first years and then starts gaining is a common one, but any year that a company records a loss means that next year’s taxes will be a little lighter.

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Why people tip in US restaurants

Here, I’ll discuss a tax incentive by the federal government to encourage bosses to have employees paid via tips instead of a typical wage.

The waitress is the only person who knows how much she got tipped. [I flipped a coin to write this example, and she came up female]. And, unless she’s in the narrow band where EIC (earned income credit) kicks in, she pays out a tax on those tips and so wants to understate her tip income.

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