Taxation and Incentives to Innovate: A Principal-Agent Approach

A principal-agent model with multiple job tasks is used to explore the effects of different tax schemes on innovation in a pure knowledge economy with bootleg innovation. Corporate taxes and labor income taxes can affect both the firm owner's and the employee's incentives to commit to innovative tasks, when the former compensates the latter (a manager or a technical or R&D employee) by means of variable pay tied to measures of the company's success. Results point to complementary roles between patentbox tax incentives and reductions in the tax rate levied on profit-sharing schemes, and they show that a revenue-neutral reform substituting the latter for the former is always possible. The complementarity holds, albeit with different relative importance for the two tax incentives, also with nondeductible labor costs and with a stochastic innovation value coupled with a risk-averse agent.