In a bid to encourage innovation, some governments nudge companies to think creatively within certain boundaries. Specifically, they introduce “innovation box” or “IP box” incentives that trim taxes on income generated from innovative activities.

The idea behind these tax breaks is to motivate businesses to pump more money into local ventures, giving a boost to the homegrown economy. But how well does this strategy work? Lester sought answers by investigating whether companies benefiting from innovation box incentives actually ramp up their investments in tangible assets like buildings or equipment. She was also curious about how these tax incentives influenced employment and wages.

Research from Stanford discovered that multinational companies only increase their on-the-ground investments if the innovation-related tax breaks are substantial and demand a physical presence or employees in the country to qualify for the benefits.

“In order for these regimes to really stimulate local activity, they have to be quite generous in the benefit that they give and they have to have really clear restrictions about a company’s presence in a country,” the researchers say.

Supporting innovation

In 2022, 21 countries used a cool trick called the “innovation box.” It’s like a tax discount for companies making money from smart ideas. Surprisingly, the United States only got on board in 2017.

The researchers checked out seven countries—Belgium, France, Italy, The Netherlands, Portugal, Spain, and the United Kingdom. These places had the innovation box before 2017. They compared them with other European nations that didn’t have this tax break.

Companies in innovation box countries invested more money—2.6 percentage points more—compared to companies in non-innovation box countries, all thanks to the tax discounts. Across the board, companies getting this tax break spent about 3.6 to 4.4 million euros extra over the next three years compared to those not getting the tax break.

The countries that gave the biggest tax discounts (between 70% and 90%) saw even more investments. The same with the places that made companies stick around and invest locally. But in countries with looser rules, companies took the tax break but didn’t really spend as much.

Not in people

But here’s the twist: companies that got these tax breaks didn’t really hire more people. Instead, they used some of the money to pay their existing workers more. After a company got a tax break, the average worker got about 45,000 euros more over the next three years.

So, what does this mean for countries thinking of trying out this innovation box thing? The researchers say that if you really want companies to invest, you’ve got to give them a big tax break and make sure they stick around and spend money locally. But be warned, it can be expensive, and both governments and companies need to think really hard about it.

Taxes are like tools countries use to compete globally. Lately, a bunch of countries agreed on a minimum tax for big international companies. They also took steps to stop countries from using tax breaks to get ahead. In Europe, new innovation tax rules say companies have to be around in the country to get the benefit.

“Innovation box tax incentives are one of the few incentives countries can still use to retain and attract business activity across borders,” the authors conclude. “Our findings show policymakers some of the ways in which these types of policies can be more effective.”