ComplianceNet

Innovation represents a market failure, and hence is supported by governments. Several mechanisms are used to encourage innovation in society: intellectual property rights, cash-based transfers (e.g., prizes and grants), and tax incentives. Tax incentives are widely employed in the U.S. and elsewhere and recently their use has been expanding. This article reexamines the desirability of tax incentives as a tool to promote innovation. It shows that tax incentives are a subset of cash transfers, and. that they differ from other cash-based instruments only by design choices. Therefore, a normative choice between innovation-inducing tax incentives and cash transfers should be grounded in identifiable systematic constraints on the design of tax or cash instruments. This article adopts a theoretical basis - an organizational theory of government - for such systematic constraints. It then applies the organizational theory to the normative choice between cash and tax incentives for innovation. The general conclusion of the theoretical analysis casts serious doubts on the social desirability of existing practices of promoting innovation through tax incentives, and explains why non-tax cash-transfers are most likely socially superior.