Fact of the Week: French Firms Just Below the Threshold for a Higher Tax Burden Were 11 Percentage Points Less Likely to Innovate Than Their Bigger and Smaller Peers

Source: Philippe Aghion, Antoin Bergeaud, and John Van Reenen, “The Impact of Regulation on Innovation,” December, 2019.

Commentary: Depending on which market sectors are impacted and how, government regulation has been credited with both spurring and detracting from innovation. Three economists underscored this when they examined how French labor market regulations—specifically, higher taxes on firms with more than 50 employees—affected firms’ willingness to innovate, as measured by their volume of patent applications. Looking at data from more than 150,000 firms from 1994 to 2007, the authors found that the tax stifled innovation for firms just below the 50-employee threshold. Specifically, given a 10 percent increase in market size—i.e., a shock that would typically spur an increase in patenting activity—firms with 45 to 49 employees were 11 percentage points less likely to innovate than firms with fewer than 45 employees, or firms with more than 50. This is because firms just under the regulatory threshold fear the “growth tax” that will be applied to them if they hire more employees, so they cut funding to innovation to avoid crossing the threshold. The “growth tax” seems to not significantly affect patenting in firms with more than 50 employees, since larger firms are more profitable and innovative due to economies of scale and have already priced the tax into their cost structures.