Abstract
Governments typically offer very attractive tax treatment to investments in research and development (R&D), because R&D is thought to be associated with large positive economic spillovers. One of the factors contributing to the generosity of tax benefits for R&D is competition among governments to attract R&D-intensive investments by multinational corporations (MNCs). In spite of the frequency with which R&D receives generous tax subsidies, and the widespread belief that these subsidies encourage the discovery and development of new technologies, very little of a quantitative nature is known about the impact of tax rules on the international location of innovative activity. This chapter examines the effect of taxation on the distribution of inventive activity between the United States and foreign countries. It analyzes the effect of U.S. tax changes, particularly those introduced by the Tax Reform Act of 1986, on the international pattern of subsequent patenting by U.S. multinationals. It shows that domestic tax incentives can significantly influence not only the rate of domestic innovation, but also the rate of foreign innovation by U.S. multinationals.