High corporate tax has negative impact on innovation investments Eric Schmidt calls for global governments to determine simplified corporate tax rules

19th August 2013, by: Global Arena

Within the public debate on tax avoidance issues, the Google executive chairman Eric Schmidt shared his view on the importance of simple tax structures to enhance technological development. 

He argues; “In reality, it is probably only a significant increase in corporation tax rates globally that would make every country a “winner” – and the consequences would probably be less innovation, less growth and less job creation.”

In his editorial contribution for the Financial Times on June 16 “Why we need to simplify our corporate tax system.” His fundamental point was; “that it is for governments to determine the rules. And when they do, companies will respond.” One response he argues is that higher taxation leads to companies reducing their investments in innovation in general or specific to that country.

It is not just the fact that corporate taxation became a viral topic in the worldwide media, that pushes corporate tax strategies on the agenda of senior executives. Taxation concerns every multinational and senior executive, because taxation of corporate assets and profits is applied in almost all countries following a unique set of complex rules. What is less known about taxation in the public domain is that corporations have to act as an extended arm of many governments to collect taxes (i.e. withholding tax, social security). Consequently, corporates deliver “own tax” and collect tax amounts to fiscal authorities. Collected taxes further raises the importance of the private sector to deliver government revenue. According to the PwC Total Tax Contribution Report (Switzerland), the collected tax amounts up to 21% of the overall fiscal tax revenue.

Following these discussions I got curious what the exact impact of the corporate tax burden on the innovation output of countries would be. Therefore we created an economic model by integrating different determining variables in order to prove the hypothesis of a negative impact of taxation on the innovation output. The geographic scope of our research covers all OECD-member-states.

The function of our simple economic model is:  P = T and GDP and GERD

  • P=Innovation in terms of patents per capita
  • T=Total tax revenue in % of GDP
  • GDP=Gross Domestic Product, per capita, PPP
  • GERD=Gross domestic expenditure on R&D

We were able to conclude a negative relationship between taxation and innovation measured by patents per capita. By increasing the tax revenue in % of GDP by one percent, the number of patents per capita will decrease by 1.39%. Consequently, an increase of taxation should be reasonable explained by knowing that it would lead relatively to a disproportionate decrease in the country’s innovation output.

Is the hypothesis supported by current statistical data on tax rates and patents?

A first impression is provided by two rankings of the OECD-member-countries according its corresponding performance.

Figure 2: PwC Total Tax Rate (PwC)

Figure 3: Patents per capita (World Bank Group)

At a first glance, it seems that this data does not directly back our assumptions, but by analysing the rankings, we could state at least for some countries the correctness of the thesis. Referring to this, we could name Australia, Belgium and the Slovak Republic as prominent pieces of evidence. 

Figure 3: Correlation between Tax Revenue (%GDP) and Patents per capita (Global-Arena.com)

But by observing the correlation table, one might be facing some contradictional findings. What about the correlations scores of countries like Canada, France, Korea or Switzerland. Are they statistical outliers or restricitions to the thesis? 

For Canada, France and Switzerland by altering time series length one might be able to conclude even a negative relationsship. Especially Canada provided us a striking conclusion that although Canada cut its total tax rate according PwC by one third in 2010, there was no impact on the tax revenue share (% GDP) oberservable. So there has to be a lag of time between the announcement and the effect of a political tax measure. 

To our surprise,it was not possible to receive any not strict positive correlation score between patents and taxation for Korea with our data. Reasons for such findings are related to its location in East Asia, compounded into a highly emerging area, guided by the intensive pace of technology. As a consequence, innovation, represented by patents pc, might be not that much tax-driven in emeriging markets as it is in more consolidated nations.  

With respect to countries like the United States of America, the data shows that taxation is not the sole determinant of innovation output. Therefore, we extended our calculation model with heuristic variables to create a more robust economic model. With the refined model we can confirm the hypothesis by proving the negative relationship between the corporate tax burden and the innovation output of a country.