New research by Tania Babina and Sabrina Howell finds “a one standard deviation increase in R&D is associated with an 18.7 percent increase in entrepreneurial spawning”—employees leaving to start new firms. It also finds “the results are robust to including four-digit SIC code fixed effects, suggesting that narrow industries do not explain the result.” The authors claim that “for the parent firm, the spawning effect of R&D yields no obvious contractual benefits, nor is it observably costly.” They observe “that a remarkable 88 percent of spawns are located in the same state as the parent.” From this, the authors conclude “the spawning effect of R&D implies greater corporate underinvestment in R&D relative to the social optimum than previously thought,” and suggest “knowledge spillovers are one motivation for offering firms tax credits that lower their cost of R&D investment.”
Their findings parallel Charles Jones’s recent work that corrects glaring shortcomings in the famous Diamond/Saez’s optimal tax analysis to show why top marginal tax rates of 30%, or less, likely maximize social welfare in an innovation-driven economy where the accumulated body of knowledge drives widespread social prosperity for everyone—a critical element of growth ignored by Diamond/Saez’s flawed analysis. Jones concludes, “When the creation of ideas is the ultimate source of economic growth, this force sharply constrains both revenue-maximizing and welfare-maximizing top tax rates. For example, for extreme parameter values, maximizing the welfare of the middle class requires a negative top tax rate: the higher income that results from the subsidy to innovation more than makes up for the lost redistribution.” Babina and Howell similarly conclude, “the spawning effect of R&D implies greater corporate underinvestment in R&D relative to the social optimum than previously thought” and that “knowledge spillovers are one motivation for offering firms tax credits that lower their cost of R&D investment.” Each seeks to maximize the rate of innovation, a primary source of prosperity.
On first reflection, it might seem more cost-effective to subsidize R&D directly rather than indirectly by reducing taxes on success more broadly. Jones argues that the successful commercialization of innovation is different than easier-to-subsidize research, critical to spawning further advancement, and inoperable to subsidize without subsidizing success.