Do tax cuts produce more Einsteins?

Bell, Chetty, Jaravel, Petkova and Van Reenen in a new working paper say not so much.  And indeed their intuitions are not surprising.  Tax cuts boost the prospects of those individuals who already exposed to the possibility of being innovators, and that is not everyone.  Talent searches — to identify and mobilize potential creators — might be more productive.  Furthermore, tax cuts could just draw in lots of marginal innovators, whereas the really important contributions come from a fairly small number of top performers.  Those top performers reap such high returns/rents that they will not so much be deterred by higher tax rates.

The key decision in their model is whether or not to enter the innovation sector, and in that setting you can see that higher marginal tax rates probably do not stop Brin and Page from creating Google and earning lots of money.  A smaller fraction of the value they created is still a huge sum.

And yet I am not convinced.  There is another way to think about and model the process.  Imagine instead that innovation is a matching process, whereby the most talented creators must be matched to the appropriate infrastructures and ecologies.  A given entrepreneur can choose to “think big” or “go small,” the latter involving less work and less risk.  Optimal marginal tax rates can be much lower in that model, because there is easier substitution into lower-valued activities, just as optimal tax rates are much lower in matching models for CEO productivity and pay.  Pushing the best CEOs to less important firms can bring big losses in output, just as pushing the best innovators to less important projects can work pretty much the same way.

You might also introduce into the model venture capitalists, namely people and firms who (among other things) help match innovators to the right projects.  If you tax innovators, might some of the incidence fall upon venture capitalists, who now must accept a lower percent of the return from the project?  And what are the secondary consequences of that?  I don’t know, but they might be quite different from what is laid out in this model.  Tax incidence should not be treated as so simple.  Innovation is not a solo endeavor (as progressives will insist on telling us in other settings), rather it is about clusters of excellence and mutual inspirations.  And when clusters matter, there is a positive externality from innovation from each innovator, which again militates in favor of a lower tax rate on innovators.  If anything, a “clusters model” would seem to favor taxes on land, not on innovation.  Furthermore, perhaps we should even subsidize top innovators.

The general point is that when matching and clusters matter, optimal rates of taxation on innovators tend to be lower.