New Tax Reform Proposals May Include IP and Other Intangibles

The absence of formal accounting, financial statement or fiscal recognition is believed by many to have hampered the adoption of intangibles measurement in corporate management. This article from Ken Jarboe's Intangible Economy blog suggests that this issue may now be addressed, due in part to corporate pressure.

Information on the I-Cubed (Information, Innovation, Intangible) Economy Tax reform includes intangibles?
By Ken Jarboe on January 14, 2011
Today, Treasury Secretary Geithner sits down to talk taxes with corporate CEOs. According to a story in today's Wall Street Journal, intangibles are already on the table:

More-targeted changes have also been floated recently by some corporate leaders, including sharp tax-rate reductions for income generated from patents and other intellectual property. Such rate reductions, known as "patent boxes" or "innovation boxes," have been adopted across Europe.

Business leaders on Mr. Obama's Export Council, an outside advisory group that looks for ways to boost U.S. exports, recently endorsed the idea, saying in a letter that a tax cut should extend to "all intellectual property that is important to the U.S. economy."

"It really needs to be looked at in the context of comprehensive tax reform," said Rep. Charles Boustany (R., La.), a member of the Ways and Means Committee who has been weighing the idea.

Critics argue that a patent carve-out could provide a windfall to some big companies and could be expanded to include logos and other less deserving types of intellectual property.

The problem, as the story goes on to note is that any new tax breaks for intangibles goes against the push for a more streamlined, simpler tax system - and against the deficit problem. The basic idea of reform is to broaden the tax base by eliminating specific tax breaks in order to be able to lower the overall rate:

Finding any new tax breaks that can meet the administration's tough budgetary standards is likely to prove a struggle. Mr. Obama is insisting that changes to the corporate-tax code not add significantly to the government's already dire fiscal problems.

That means the budgetary cost of new tax benefits--including a lower rate--likely would have to be made up through elimination of other popular business breaks.

Administration officials said they were open to corporate leaders' suggestions for specific breaks such as a patent box, but cautioned against breaks that add to deficits.

"If someone has an idea for greater incentives for investment, great," one official said. "But I hope they come with ways to accommodate it within [the standard of] revenue neutrality."

At the meeting where the president's Export Council approved its tax-overhaul recommendations last month, outgoing White House economic adviser Lawrence Summers encouraged business leaders to come up with ideas for spurring investment, but also urged them to avoid seeking a grab-bag of tax breaks.

"The case for investment incentives is compelling," Mr. Summers said, according to a transcript. But "if the business community formulates a wish list [without regard to budgetary impact], that is not a strategy that, in my judgment, is very likely to get to the end successfully."
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While the idea of tax incentives for intangibles should be looked into (as we advocated back in our report Intangible Asset Monetization: The Promise and the Reality), let me suggest a slightly different approach. As I noted in an earlier posting, one of the principles of tax reform is that the tax code should not distort investment decisions. Our current system basically acts as a dysfunctional industrial policy with a myriad of very narrow tax breaks for specific industries.

Having said that, there are reason why certain investments should be encouraged over others. For example, I have long advocated a knowledge tax credit because of the market failure issues of free-riders and spillovers (which distorts companies incentives to invest in worker skills).

But as a larger principle I would go back to the economic argument of treating investments the same. Specifically, that principle needs to be extended to treating investments in intangible assets the same as tangible. The tax code should not distort investment decisions by skewing them toward physical assets.

How to do that may be difficult. In some cases, it may be a straight forward policy of including intangibles in eligibility requirements. For example, in the tax deal we should have extended the provisions allowing industrial development bonds (IBDs) to be used to finance facilities manufacturing intangible property. Instead, we went back to the old distorted system where only traditional factories were eligible for this program and new facilities for software development or bio-tech research facilities were excluded.

In other cases however, the tools to foster investments in physical assets are different that those for intangible assets. For example, the quickest way to encourage investment in plant and equipment is through accelerated depreciation -- which we did in the latest tax deal. Since investments in intangibles are already expensed immediately, this tool does not work. Instead, we need to think more in terms of parity. For example, I would have used at least part of the $146 billion allocated to the physical capital investment tax break (expensing of plant and equipment) for this human capital tax break (a knowledge tax credit).

Obviously, the question of taxes and intangibles is a very complex issue. But as we move forward on tax reform, it needs to be at the center of the discussion. If we fail to set a coherent policy on how the tax system fosters investments in intangible assets, we will have failed to come to grips with what is truly driving economic prosperity.