Death and Taxes Should not be Certainties for the Patent System

The Department of Commerce has floated a proposal to tax U.S. patent holdings as a means of reducing the national debt, as outlined in a recent Wall Street Journal article. It is a bad idea that reflects a troubling misunderstanding of both patent law and innovation economics. Framed as a revenue-generating mechanism that could purportedly bring in “a few hundred billion dollars per year,” the proposal not only risks inflicting long-term damage on the innovation economy it supposedly supports but also raises constitutional red flags.

The proposal centers around assigning a value to each issued U.S. patent and taxing it accordingly at some rate between 1% and 5%. To be clear, this is not a tax on the income realized from the use of a patent, it is a tax on the value of the asset itself. That is, it is a wealth tax levied only upon innovators. Just a few months ago, some parties were protesting loudly that imposing a Federal wealth tax would be unconstitutional.[1] They argued such a tax would run afoul of Article I, Section 9 of the U.S. Constitution, which prohibits any direct tax “unless in Proportion to the Census or enumeration herein before directed to be taken.” A patent tax certainly would not be in proportion to the population, meaning it raises the same Constitutional concerns as a tax on individual wealth, only here it would drag down innovation rather than just certain peoples’ finances.

But even at a conceptual level, this idea is fundamentally flawed. The value of a patent is notoriously difficult to pin down. Unlike real estate or stocks, a patent does not carry any positive rights (like the right to occupy real property or a fractional right to control a company). Rather, it is the right to exclude others from an invention – a right that only has value based on the desire of others to practice the invention. Furthermore, the worth of a patent may fluctuate wildly over time depending on external factors like technological adoption, litigation trends, and market dynamics. A patent that appears worthless today might become central to an emerging technology tomorrow. Conversely, the technology of a once-promising patent might prove commercially unviable or be invalidated by the courts or the Patent Trial and Appeal Board (PTAB). And even if a patent is assumed valuable for excluding an infringer, reasonable valuations can vary by orders of magnitude – damages experts in patent litigation can come up with wildly divergent proposed damages valuations despite starting with the same assumptions. Taxing an asset with such volatile, context-dependent value would introduce significant administrative overhead and compliance burdens, all for an unreliable stream of revenue.

This proposed tax would fall unevenly across the economy, affecting different industries in different ways, but always disincentivizing innovation. In life sciences, where patents are often held for many years before a product covered by the patents reaches the market (if it ever does), the burden would fall disproportionately on early-stage innovators who are hoping for a payoff when a Big Pharma company swallows them to acquire their patent rights (among other things). It would slow innovation, which would be detrimental to both branded and generic pharmaceutical companies, all of whom must develop a pipeline of drugs to ensure continued vitality, not to mention patients who would be less likely to have access to innovative new therapies. In contrast, many engineering or software patents are used defensively or become obsolete quickly, meaning the incentive would be to let them lapse rather than pay ongoing taxes. And, in fact, it would create an incentive to avoid the patent system and keep information as trade secrets, thinning out the marketplace of ideas. A one-size-fits-all tax on patent ownership fails to recognize the varied strategic roles patents play across sectors.

The tax would also create incentives for patentees to “adjust” the value of their patents according to the circumstances. Under this regime, patent holders would be motivated to report lower values in order to reduce their tax liability. But this might drive down corporate valuations or increase difficulty in obtaining loans secured by intellectual property assets. And it could backfire spectacularly in litigation or licensing contexts, where low prior valuations could be used against a patentee to diminish damages or weaken bargaining positions. In general, identifying variable asset valuations can lead to damaging legal or business exposure.

There is also a darker incentive embedded in the proposal: the possibility of boosting patent grants to juice revenue numbers. By associating the United States Patent and Trademark Office (USPTO) with the tax income and self-declared value of issued patents, the system would encourage the USPTO to issue more patents, regardless of quality, in order to inflate the tax revenue for which it can claim responsibility. The result would be a bloated patent landscape littered with low-quality, litigation-prone patents – the outcome opposite of the USPTO’s charter and purpose.

Innovation in the U.S. has been under attack for decades, and the proposed tax would further hollow out our science and technology pipeline. Facing an additional financial burden, many patentees, particularly startups and individual inventors, would choose to avoid the patent system altogether or let patents lapse by skipping maintenance fees. This effect compounds the already chilling atmosphere created by Alice Corp. v. CLS Bank, which placed arbitrary restrictions on software patents, as well as the PTAB’s aggressive invalidation of issued patents. A patent system that is expensive, uncertain, and toothless adds no value for innovators. It becomes a paper tiger, offering rights that look impressive but have no teeth.

Given all of this, the revenue projections for a patent tax from the Department of Commerce appear to be wildly optimistic. If the tax causes patentees to shrink their portfolios, then the expected haul of “a few hundred billion dollars” would similarly shrink. The tax would create a short-term windfall followed by a persistent erosion of the asset base that it is trying to exploit. The government would tax innovation toward extinction and then wonder where the revenue went.

The proposal outlined by the Journal boils down to placing a wealth tax on a specific asset having an unclear value in the hopes of generating money that will likely never appear. In doing so, it promises gut the very system that has made the U.S. a technological superpower. The proposal is not even close to sound fiscal policy. It is just plain bad.

[1] https://www.politico.com/news/2024/06/20/supreme-court-wealth-tax-00160593