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A Harberger Tax on Patents
Self-assessing innovation taxes for fun and profit
I’ve been interested to read about new obesity breakthrough drugs — Eric Topol provides a nice overview here (also NYT). The main takeaway is that we now have several drugs which, under rigorous clinical trials, show large reductions in body weight on par with what is typically achieved through gastric bypass surgeries.
These drugs do so through a variety of mechanisms, including higher satiety, delayed gastric emptying, and insulin regulation. The impacts from weight reduction and direct metabolic effects appear to be quite favorable, in terms of reduced body lipids and blood pressure. There are also some resulting negative side effects, such as nausea and vomiting, which are severe enough for some patients to stop using the drugs. The model of delivery — weekly self-injections — is also challenging, but there are is a pill for one of these drugs (semagutide, approved for glucose regulation) which also leads to weight loss, albeit more modestly.
By all accounts — I’m certainly not novel in saying this — these drugs seem to have profound implications. Most obviously, they offer the promise for large health benefits for individuals dealing with diabetes and obesity. My guess is they will also enter broad usage for people just looking for off-label benefits of weight-loss: particularly on a temporary basis (it seems these drugs mostly work while you are using them). This is already happening. The Peltzman-wallahs are also worried about moral hazard: that people will simply risk obesity much more given this safety valve, which does not particularly concern me but there you go.
I am interested, however, in the financing angle — how are we going to pay for these drugs?
The economic problem behind innovation is well-known. The basic problem is that prescription drugs entail large up-front R&D expenses, but are very cheap to produce. To incentive this R&D, we grant drug makers monopoly prices on the resulting sales. Because these companies then sell to insurance companies with somewhat inelastic demand for covered patients; you typically end up with very high drug prices far from social optimum. The drugs we are talking about might cost something like $1300/month, and insurance companies typically put up high barriers to drug access (ie, through prior authorizations). We’re going to have lots of people for whom it’s economically beneficial to offer these drugs, who are going to get rationed out.
The canonical solution to this problem is what Michael Kremer has suggested in the form of patent buyouts. The government could simply purchase these patents from companies and place them in the public domain, thereby preserving incentives for initial research while also eliminating the inefficiencies resulting from monopoly pricing. A huge win-win!
Improving Patent Buyouts with a Harberger Approach
However, I think we can do even better with a Harberger, or self-assessed tax, approach to patent innovation. This idea is often expressed as a theoretical curiosity, so I think it’s helpful to start out with a real world use case which shows how this works. The King of Denmark financed a large chunk of government revenues, for hundreds of years, by asking cargo ships passing through their strait to self-assess cargo value, and pay a tax on the value. This generates natural incentives to self-assess for too little. So the King also retains the right to buy the cargo at the self-assessed price. Now you want to avoid the King buying your cargo for too little; so you are naturally incentivized to state the true price.
Eric Posner and Glen Weyl have recently brought Harberger taxation back in discussion by proposing that we use these kinds of self-assessed taxes more broadly.
As an aside — I actually think their main proposed use case for property taxation isn’t the best place to start. Their idea is that you should self-assess your property value, pay a tax on that value, and be prepared to sell the property to anyone who shows up with that amount of money. But do you really want to think about the value of your house every year, and have to move if you just misjudged the true price and some more sophisticated investor buys you out? And what if you have a high match value with your property, or are just risk averse and want to avoid moving frictions? You effectively have to self-report a high value to keep the property; and now we are taxing the private valuation of the property/risk aversion of the resident. Doesn’t seem great.
I think because people recognize that self-assessing and selling personal property is a little extreme; this general idea has been seen as a little out there.
But Posner and Weyl also discuss applying this to patents, and have this to say:
Harberger taxation could be applied to intellectual property rights to deal with the infamous problem of patent thickets and trolls (Eisenberg & Heller 1998). If intellectual property had to be self-assessed and was taxed, with corresponding increases in its duration and possibly even the payment of some of the associated fees to the original inventor to maintain incentives to innovate, this might significantly mitigate the problem of patent trolls buying up swaths of intellectual property just to holdup potential users (Cohen, Gurun, & Kominers 2016). It would also help avoid the holdout problems associated with assembling many complementary intellectual property rights to create standards or products that require many patents together.
So how is this going to work? Let’s apply this to the specific case of the obesity drugs:
When drug companies apply for a patent, they would be required to self-assess the market value of the resulting patent. This appears to builds on some existing work that firms filing for patents have to report anyway (like the scope of the market, etc.). You would then update the market value of the patent, over time, reflecting the firm’s own assessment of the true value.
If you are granted a patent, you then have to pay some fraction of patent value as an ongoing expense. To be sure, reducing the payoffs to innovation will reduce, on some margin, the incentives to innovate. But we are only going to require this tax if the firm actually gets the benefit of the patent. So it’s unlikely to operate as a financial friction, preventing the firm from taking up a positive investment due to lack of initial cash flow.
Plus, as Posner and Weyl point out, requiring holders of patents to make periodic regular payments helps to avoid patent trolls — people who just fill out (or buy) existing patents and just sit on them, hoping to sue other innovators out there. A higher user cost of patents, in other words, should encourage more efficient utilization of the patent monopoly.
With the self-assessed value in hand, the government (or other non-profits, or potentially even any other private firm) has the option to buy out these obesity drug patents. There is a high wedge between monopoly pricing and the marginal cost for these drugs, and huge benefit to people if they take them, so there will be massive social benefits to buying out patents like these.
So here we are just doing the Kremer patent buyout thing — but because we also have a patent tax, the government is actually collecting the resources, from the stock of all patents, which allows them the funding to do these patent buyouts. A key limitation in preventing governments from actually implementing these patent buyouts is the cost, and the fact that they are going to compete with innovation funding elsewhere. In a perfect world, we would just have lots of resources to pay for lots of innovation. But, if we are constrained, the Harberger solution provides additional government tax revenue which can be used to pay for patent buyouts without cutting other government services or raising taxes.
So this generates a budget-neutral strategy for the government to help reduce patent trolls, and make sure socially valuable innovation broadly accessible. Seems good!
I do a
weekly semi-regular thread on what’s happening in India; here’s the latest version focusing on air pollution and state capacity:
I also went to the Skyscraper Museum, which has an interesting exhibition on office to real estate conversions:
Thomas Flanagan has a nice JMP focusing on the value of bank lending. He finds that banks generate some alpha on the loans they make, resulting from better screening and monitor, and share some of these rents with borrowers. To measure the value of these loans, he extends the “strip by strip” valuation approach I’ve worked on with Stijn (discussed here).
Matt Staiger finds that 29% of people actually work for their parent’s employer once by age 30, and these same-firm work arrangements appear to be valuable for workers.
There are some interesting contrasting results on pay transparency. One paper by Morten Bennedsen, Birthe Larsen, and Jiayi Wei, fairly robustly across countries, that making wages open tends to lower wages, particularly for men compared to women. But Zoe Cullen, Shengwu Li, and Ricardo Perez-Truglia find that making wage data available to firms increases wages.
My interpretation is that you can have benchmarking effects that go in different ways. When firms have this information, they appear to bid more aggressively for workers. But when they know that employees will also have this information; they bid less aggressively (they want to avoid other workers demanding similar increases). Maybe that suggests that optimal pay transparency rules make this information available only to firms, or aggregate across firms, not including firm-level benchmarks, to avoid this within-firm monopsony problem.
Noah Smith has a nice roundup of work on NEPA — the environmental process regulation which seems to be holding up infrastructure and housing.
There has been a lot of attention lately given to open-ended funds owning illiquid assets — like Blackstone’s BREIT or Sequoia’s Capital Fund. The WSJ talks about how you are seeing a lot of withdrawals from the real estate funds, and the FT discusses whether we are just seeing hidden financial risk in the form of these liquidity mismatches across markets. Spencer Courts has a nice paper on these funds, focusing on the role for liquidity buffers and liquidity restrictions.
An interesting paper by Zhiguo He, Scott Nelson, Yang Su, Anthony Zhang, and Fudong Zhang on Chinese land markets. They argue Chinese local governments face a tradeoff between selling residential land (fast payoff; but historically no property tax) and industrial land (more cash flows down the road). And so the cash squeeze faced by local governments influences the development strategy. One impression I have is that it seems the Chinese government should just go more Georgist: higher property taxes would also increase the long-term benefits of building more residential real estate for local governments.