Patent fees as a tax on so-called ‘monopoly rents’: a response

March 17, 2011

By Assoc. Prof. David Brennan

In his post Shaun Larcom explains the findings of Gaetan de Rassenfosse and Bruno van Pottelsberghe. Their research shows that great variation exists between territories as to patent fees, but that variation does not appear to cause a commensurate impact on patenting activities as between territories. This reveals that demand for patent applications and patent renewals is inelastic (i.e. unresponsive to price change) and the authors observe that this did not mean that patent fees were an ineffective policy tool, but that ‘a change in fees must be sufficiently large to have observable effects’. The question is put by Larcom: what is a socially optimal fee structure? Larcom argues that patent fees could have a taxation role, targeted at ‘the monopoly rents that accrue to patent holders’. For the reasons stated here it is argued that this should only be done if a conscious policy decision has been made to reduce the incentive effects of the patent system.

Deciding whether to have a property system of patents for inventions entails social choices.

The primary social choice is whether or not to institute patent property. Over time it has been largely accepted that temporally limited property rights for inventions confers net social benefit by providing measured incentives to accelerate the rate of technological progress, and to provide those incentives in such a way that they are conditional on full disclosure. The rationale is economic. The promise of being able to appropriate value from market demand for the patented technology per se is intended to have stimulating effects upon conduct likely to yield more technological progress – such as investment in R & D. After the patent term expires, the disclosed technology is absent any property rights.

Another social choice is how to conduct a merit assessment of that which is patentable. It has been long agreed that patents for existing or obvious technology is unjustifiable. Such grants do not stimulate worthwhile progress and restrain existing trade. It is largely accepted that best practice involves assessing the merit of inventions the subject of a patent application, and the written application itself, prior to grant. Such assessments are complex. The exercise involves integrating technologies that are at the edge of human understanding with a body of difficult law. Employing sufficient quality human capital to administer a patent system is expensive. How is a nation’s patent office to be properly funded?

The current IP Australia fee structure to acceptance for a standard patent is between about $1000 and $2000 depending upon the circumstances of the particular application. (For example the acceptance fee of a patent application with more than 20 claims entails $100 for each claim in excess of 20.) The current IP Australia fee scale for standard patent renewal is

5th anniversary $250

6th anniversary $250

7th anniversary $250

8th anniversary $250

9th anniversary $250

10th anniversary $450

11th anniversary $450

12th anniversary $450

13th anniversary $450

14th anniversary $450

15th anniversary $1,020

16th anniversary $1,020

17th anniversary $1,020

18th anniversary $1,020

19th anniversary $1,020

If term extended, $2000 for each anniversary during the period of extension

What should underpin the setting of such fees? In my view it should simply be to fund the patent system by a user-pays principle.

Because a patent office is expensive, it needs to be funded. While inventors can use the patent system, they do not need to. For example sheer secrecy and/or merely first-to-market advantage provide alternative means to confer comparative advantage upon inventors. If an entity relies on patent incentives and avails itself of the patent system, it is apt that the entity pays for the system. Patentees derive a clear private benefit from the system. But the total fee take should not be more than that required to properly fund the patent office.

What is the extent of such use in any given case? Given that the direct users of the patent system are mostly patentees, the extent of any use must be measured by degree of reliance on the patent system. The logic underpinning the current fee structure reflects this thinking. Most obviously, the more patents applied for and renewed, the greater will be the fees payable by a user. But extent of use can be differentiated, and usage pricing accordingly discriminated as between individual usages. For example X and Y might each apply for and be granted a respective patent. X has invented an improved device for which there is no market demand; X might maintain the patent for short time and then surrender it. Y has invented an improved pharmaceutical which is heavily demanded; Y might obtain a term extension of the patent. X and Y are each required to pay quite different total fees to IP Australia in relation to their patents. This is because while each has used the patent system in relation to their respective patents, the extent of patent system use of X and Y is very different. On user-pays principles, Y should make a bigger contribution to the running of the patent office because the extent of its reliance on the system is higher than X.

There may be very good arguments for revising overall fee levels to ensure that a country’s patent office is properly resourced and employing sufficient numbers of talented people. However it seems that the basic features of total fees being no more than that amount necessary to fund such a system, and fee pricing set on the basis of a user-pay principles, are sound. In contrast Larcom’s idea is that patent fees should also be a tool to tax (so-called) ‘monopoly rents’ accruing to patentees. This seems less desirable unless an informed policy decision has been made to reduce the incentive effects of the patent system.

Underlying Larcom’s approach is the philosophical view that ‘optimal innovation policy would aim to eliminate the monopoly rents that accrue to patent holders’. A person owning a patent is not a monopolist any more than is a person owning a block of land – indeed the land owner has stronger property rights than a patentee. Once the basic social choice is made to have a patent system, its justification is the incentive effects of the promise of patent property. Property, while central to the operation of many markets, is a concept defined in law. The defining attribute of property is the owner’s entitlement to exclude the world from carrying out certain activities, and to secure the assistance of the law in carrying out a decision to exclude. Exclusive rights therefore require most third parties desirous of lawfully exploiting the patent resource to bargain with the owner. In that licensing bargain, the owner is able to appropriate to itself some of the value accruing from a third party licensee’s exploitation. Value will be appropriated by the patent resource owner which is vastly in excess of the marginal cost to it – typically zero – of providing of the patent resource. This is an inherent feature of patent incentives in the first place. The promise of appropriating some third-party value from the licensing of an owned patent resource with a zero marginal cost of provision is the very incentive which justifies the patent system.

Therefore if (as Larcom says) ‘optimal innovation policy would aim to eliminate the monopoly rents that accrue to patent holders’, and if that is to be done (as Larcom suggests) by changing the law so as to tax through patent office fees that appropriated value, such taxation must reduce the incentive effects of the system.

It is far from clear that current patent incentives are excessive and require such a change. Whether or not existing incentives are excessive such as to create ‘monopoly rents’ and misallocations of resources is highly contestable. Is there evidence, for example, of over-investment in R & D caused by such excessive incentives? This uncertainty is especially so given that the promise of the patent system enables a prospective patentee to invest in different avenues, knowing that one commercially successful patented technology can offset expenditures in avenues that prove unsuccessful. It is equally unclear that there are strong policy justifications that patentees’ revenues should be subjected to higher taxes than others engaged in industry – whether those industries are intellectual property dependant or not. While the patent system should be self-funding through fees set under sensible user-pay principles, taxing patentees more highly than others in industry should not be considered unless an informed policy decision has been made to reduce current patent incentives.

David Brennan is an Associate Professor at the Melbourne Law School

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Review Article: The role of fees in Patent Systems: Theory and Evidence by Gaétan de Rassenfosse and Bruno van Pottelsberghe de la Potterie

March 4, 2011

By Shaun Larcom

In many countries, including the United States, patent filings have soared, and there are severe backlogs.  Also, there are questions being raised over the quality of incoming patent applications.  Within this context Gaétan de Rassenfosse and Bruno van Pottelsberghe look at patent fees and how they can be used as a policy tool in a recent working paper published by the Centre for Economic Policy Research.  Their work looks at how the magnitude of fees has changed over the last couple of centuries in the United States, how fees vary considerably between jurisdictions, how fee changes affect the number of applications, and finally what an ‘optimal’ fee might look like.  The authors note that patent fees are generally applicant friendly and priced with administrative cost recovery or international harmonisation in mind.

We learn that the first U.S. Patent Act of 1790 set fees of around $5 per application, which was intentionally low, to simply cover the cost of issue.  However, three years later the fee was increased to $30 to make it comparable to European systems, and presumably well above administrative cost recovery.  After this, while fees in the United States increased in nominal terms, they stayed much the same once adjusted for general price inflation until the 1960s at around $600.  In this decade they increased significantly and since then have broadly stayed the same, once adjusted for general price inflation and now stand at around $2500.

The authors argue, however, that this presents a misleading picture.  They consider that a better measure of the relative price of fees is one that is adjusted for increases in wealth, or increased potential earnings from patents.  When the fee is deflated using GDP per capita, which accounts for increases in total income, rather than just price increases, patent fees in the United States are at an all time low and are approximately one tenth of 1800 level (see chart below).  As we have become much wealthier, fees as a proportion of total income that can be expected from an average patent is the lowest it has ever been.

Evolution of United States application fees adjusted for income: 1790-2005

Source: de Rassenfosse and Bruno van Pottelsberghe 2010, p6.

The second thing we learn from their work is that fees vary considerably across nations.  To take the two extremes, total patent fees are more than five times more expensive in Japan than in Switzerland.  However, the authors look deeper at cross-country comparisons.  They point out that these costs need to be weighted for market size, as patent protection in a large economy can be more cost effective than in a small economy even though fees might be higher.  For instance, even though Finland has similar fees to the United States the Finish market is more expensive to protect in relative terms as its market is many times smaller than the United States.  Once they account for market fee costs to market size, a very different picture emerges.  China and Japan, two of the countries with the highest nominal fees are among the cheapest on per capita basis, and the Nordic countries are among the most expensive.  They also find that the European market is up to 13 times more expensive to cover compared to the United States even after accounting for the cost savings brought about by London Agreement, which reduced the translation requirements for patent validation procedures in key European countries.

The authors also look into how fees may affect the number of patent applications. Surveying various studies, including their own, that look at the effect of fee increases or decreases on patent applications.  While the results vary, changes in fees seem to have a small effect on patent applications, which is not surprising as the fee is likely to be a small component in overall application costs.  In their own work, which uses data for 26 years from the European Patent Office, Japanese Patent Office, and United States Patent and Trademark Office they estimates a long-term elasticity fluctuating around -0.30.  These results suggest that a 10 per cent increase in fees should lead to a 3 per cent fall in patent applications over time. The authors point out that because an increase in fees lowers demand by a smaller relative amount than the increase in revenue, higher fees would actually increase the patent office’s income.

Given that patent offices could easily increase their revenues by charging higher fees suggests that governments are IP friendly and see the benefits generated by the monopoly power of a patent as greater than the costs it imposes on consumers.  Alternatively, they may not have thought of using patent fees as a policy tool.  The authors argue that issues associated with the applicant’s behaviour and welfare issues are rarely considered.  After surveying the literature, they also find that work by economists has focused on the optimal length and breadth of patents, and studies on the optimal fee policy are scarce.

It is well understood that patents have the potential to generate high levels of R & D in new technologies that may benefit not only the holder but society as a whole.  However, we also know that these benefits are not without cost, as patents also explicitly generate monopoly power which can see high prices and other detrimental effects that results in some consumers unable to buy or use the new technology.  With this in mind, the authors survey the relevant economic literature.  Gans et al (2004) suggests the socially optimal level fee structure is initially low, but that renewal fees are as high as possible such that the inventor would be willing to undertake the inventive activity in the first place.  Others, such as Baudry and Dumont (2009) suggest initially low patent fees but a sharp increase in a final fee around year 14.  Such fee structures are aimed at inducing the necessary investment while minimising the social costs of a patent.  That is, high renewal fees may have the ability to avoid excessively long patents from a social perspective.

From an economic point of view the optimal innovation policy would aim to ensure that new technologies are developed but that costs associated with monopoly power are minimised.  We know how to achieve this, at least in theory.  Optimal innovation policy would aim to eliminate the monopoly rents that accrue to patent holders.  In economics, the term rent has a specific meaning, and can be defined as the difference between the price someone is willing to receive to conduct an activity versus what they actually receive.  For instance, a mining company would be willing to invest in a new mine at a certain ore price, if this price doubles, the increase in profit brought about by the price rise is rent.  The economic argument goes that even if all this rent is taxed, the mining company would still invest in the new mine and make profits, but that the risk adjusted profits would be no greater than if the capital was employed elsewhere.  While estimating economic rent is not easy, it is possible.  The Australian government has been calculating and taxing economic rent generated by offshore petroleum producers for decades.

The work by de Rassenfosse and van Pottelsberghe puts patent fees into a historical, international and economic perspective.  We learn that patent fees as a proportion of potential income generated is at an all time low.  From their survey of the literature we also find that patent fees have the potential to be an important policy tool for innovation policy, but that up until recently this has been ignored.  Indeed, fees could be used as a tool to tax economic rents generated by patents, or to reduce the life of a patent, while still encouraging investment in R & D.

Gaétan de Rassenfosse and Bruno van Pottelsberghe de la Potterie, The Role of Fees in Patent Systems: Theory and Evidence, June 2010, Centre for Economic Policy Research Discussion Paper Series No. 7879.

Shaun Larcom is a PhD candidate in law at the University College London’s Centre for Law and Economics

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