The Complex Role of Public Innovation Capital

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By Rob Philbrick

The notion that a state, county, or city should have a limited role in the development of local innovation economies stems from neoclassical economic theory, which advises that competitive markets be left alone so optimal outcomes can occur. I suggest a different notion: public commitment to invest across our local innovation chain is a desirable outcome.

Public investment plays an important role in setting foundations, while private finance is better suited for commercializing the innovative ideas born from these foundations. Neither one acting alone is sufficient.

Economist Mariana Mazzucato, author of The Entrepreneurial State, suggests the public-private relationship with innovation investment should be symbiotic, not parasitic. Private investment is properly incentivized to enter the R&D space of certain industries and sectors – and therefore promote long-term growth – only when the public sector makes the more expensive, capital-intensive investments in new opportunities early-on to set a strong foundation for research and innovation. Ultimately, public innovation capital need not “pick winners” in technology sectors like the life sciences, green technology, advanced aerospace manufacturing, and biotechnology. Instead, its role is to “de-risk” the sector by identifying spaces ready to move forward with research and development.

Washington State has some history of making public investment in these capital intensive sectors. In 1995, Washington first implemented a broad R&D tax credit in the form of RCW 82.63. Ten years later, the Life Sciences Discovery Fund (LSDF) was established to support university research and grow Washington’s life sciences sector. Between 2007 and 2012, the LSDF made $88 million in grants and grantees saw an eight-fold return through follow-on grants and health care cost savings. In 2015 however, after an up-and-down ten year run which saw several efforts to retool the fund so that it supported both industry and academic research, state lawmakers stripped the LSDF of all funding.

Today, Senate Bill 5630 aims to reinstate tax preferences similar to those seen in the broad R&D tax credit of 1995. If SB 5630 is enacted into law, down-the-road private capital investment benefits from this up-front de-risking.

The language of SB 5630 describes the legislature’s public policy objective of improving competitiveness and creating or retaining more jobs. To achieve this, the bill proposes a reinstatement of the Business & Occupation (B&O) tax credit for advanced spacecraft manufacturing, life science (biotechnology and medical devices), and environmental technology research and development companies. The bill also proposes a Sales and Use tax deferral for certain types of construction projects undertaken by new and expanding companies conducting research and development in these fields. Part of the goal of these proposals, beyond reducing R&D and construction costs, is to encourage overall industry investment in R&D. The bill aims to increase the number of companies performing R&D activities in these spaces, which would in turn lead to more jobs and a higher tax base over time.

Per SB 5630’s fiscal note narrative explanation: “The B&O tax credit is up to $500,000 annually for eligible R&D expenditures or 80 percent of the compensation received for conducting qualifying R&D.” These qualifiers make sense when concerned with certain types of businesses, but not with others. One issue is that eligible R&D expenditures must exceed 0.92% of the firm’s taxable income. Requiring certain income levels before tax incentives are applied may leave younger, high-growth, pre-revenue companies scrambling to stay alive – whether their research has long-term commercial value or not.

In the end, SB 5630 is highly unlikely to pass. Washington invests public funds with predictable caution, and the state simply will not direct funds to this type of initiative right now. Successful public investment is proactive, bold, and patient; its role is to de-risk later private investment by taking a long-term approach across the entire innovation chain. However, if this is not the state’s view, then public investment will continue to be led away from technology research and entrepreneurial capacity.

So, it appears to be time for a new conversation – the purpose of which is to generate creative public innovation capital programs. I would call for local municipalities to generate their own momentum in this space by leveraging the individual and pooled public investment funds at their disposal. The next chapter of this story will be written by cities and counties when they push for and enact unique public innovation capital programs.

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