Patents, tax shelters, and the firm.

For most goods and services, the normative evaluation of these effects would be relatively simple. Insofar as most goods and services that meet a market demand increase net social welfare, then a policy that leads to more creation and faster diffusion of those goods and services is generally a good thing. However, tax investment strategies may not be an ordinary service. There exists a fairly strong argument that such strategies create a net social harm--they induce citizens to waste resources on planning that lowers income to the government. (49)

Of course, this is to some extent a cost of adopting a tax system in the first place. Taxation itself introduces distortions into the market, changing the effective prices of goods and services, altering price signals, and so changing the output of goods and services in response to such signals. (50) At its best, taxation aims to solve the problem of underproduction of public goods--the same problem addressed in part by the patent system. However, depending upon the placement of tax surcharges, the distortions created by taxation may run the gamut from intentional corrections for market failures, to intentional subsidies for politically favored outcomes, to unintentional penalties for otherwise productive activity.

If a tax investment strategy constitutes a deliberate governmental correction of a market failure, or subsidy or incentive toward a preferred type of economic activity, then patenting that strategy might frustrate Congressional purposes by excluding investors from the desired activity. This scenario seems unlikely to us, however, as patents must meet statutory criteria of novelty and non-obviousness. (51) If a particular investment strategy has been openly contemplated and debated by Congress, that public discussion likely renders it obvious and publicly known, and so by definition unpatentable. In order to be "innovative," patentable tax shelters are likely to be previously unnoticed and probably unintended "loopholes" in the tax system.

We leave it to others in this symposium to argue whether non-abusive tax planning is a social bad. For this portion of our article, we assume that it is a bad, because that complicates our normative analysis. If you reject this assumption, you can ignore the remainder of this part, and simply conclude that business method patents are likely to have a net positive effect if our analysis in the preceding parts is correct.

Given our assumption regarding the downside of tax planning, does it make sense to use patent law as the preferred tool to intervene, in order to dampen the effect of business method patents toward increased use of new tax planning strategies? A simplistic initial answer might be to concentrate instead on Service enforcement as the best way to discourage tax planning strategies rather than tweaking patent law to achieve this goal. However, a relatively simple theory of the second-best approach (52) calls that answer into question. Service enforcement and rulemaking are highly imperfect in their ability to discourage inefficient planning strategies. Given such limitations, perhaps it makes sense to use another policy tool, patent law, to supplement the imperfect tool of tax law.

While this argument seems attractive, we believe that the initial simplistic answer is the right one: the better approach is to concentrate on tax law and on Service enforcement as the primary tools to combat unwanted tax planning and leave patent law out of tax policy. For one thing, business method patents will have some positive effects. More importantly, even if the negative effects outweigh the positive effects, as seems likely, there is just no way to fiddle with patent law as applied to tax planning without bad results in much bigger areas of patent law. (53)

Consider both the static and dynamic effects of making business method patents available for tax planning. Start with the static effects. Insofar as a patent gives the patent holder some ability to raise its price above the competitive level, it will thereby reduce the amount provided given the existence of the service. Normally that's seen as a bad but necessary consequence of patenting. (54) Here, it is a positive effect--it means that some people will not use a patented strategy who otherwise would because of what they will need to pay for the license to use the strategy. If we want to discourage the use of tax planning, that is a good thing.

Another possible positive effect is on public disclosure of tax planning strategies, which may affect the ease of Service enforcement. As in the case of other trade secrets, the availability of patents seems unlikely to prompt disclosure of tax investment strategies that would otherwise remain confidential indefinitely. However, patents might possibly assist in prompting the disclosure of tax shelters on the margin of confidentiality, that is, investment strategies unlikely to remain secret for longer than the term of the patent. To the extent that this occurs, patenting may actually be beneficial in allowing the Service to identify dubious investment schemes; the published patent applications may be one place where tax investment schemes can be monitored.

Of more consequence, though, is the long-run effect on innovation and diffusion of innovation. We focused mainly on this effect in the previous parts. Even there, we see some ambiguity. The anticommons effect could reduce the amount of innovation that occurs (55)--which again would be a good thing, in the topsy-turvy world where we do not want innovation in this particular service. Thus, trying to limit the patenting of tax strategies may be counterproductive if indeed the anticommons effect dominates.

Of course, we do not believe that it is likely to do so. Hence, we do need to face up to the likelihood that business method patents will encourage more innovation and diffusion of tax planning strategies in the long run, and that may indeed be disturbing. Under this scenario, we must consider whether such a proliferation of tax planning strategies can be curtailed through patent law. Recall our earlier discussion of the slippery slope that led to business method patents for tax planning strategies in the first place. (56) Given the inexorable transition from software patents to business method patents to tax shelter patents, is there anyplace on this slope where patent policy can call a halt to the slide? One could of course imagine attempting at several junctures to hold the line. Moving from the specific to the more general, one might try to hold the line against acceptance of abusive tax planning patents, or against acceptance of all tax planning patents, or of investment strategy patents, or of business method patents, or for that matter of software patents.

But this strategy is doomed by what Mark Lemley and Julie Cohen have in the software context called "the doctrine of the magic words"--past prohibitions against software patents were easily elided by drafting patent claims so as to avoid the term "software" and instead drafting in terms of some other subject matter--the state of a wrist watch or the function of a pizza oven, perhaps. (57) The patent issues just the same, and covers the software, but in terms that thinly disguise the subject matter. This was the situation in the United States until the United States Court of Appeals for the Federal Circuit declared an end to the facade in its State Street decision; it remains the case today in foreign patent offices such as the EPO. (58) Even under a subject matter prohibition, one can always get a software patent, so long as it is denominated properly in the claims.

Much the same result could be expected of attempts to block investment or tax planning patents--avoiding such prohibitions simply becomes a claims drafting exercise in avoiding certain terminology. There is no particular reason that the claims of a tax planning method patent need mention "tax shelter" or even the word "tax." To be sure, the patent must disclose some utility for the investment system, but so long as that disclosure is couched in the terminology of investment rather than the terminology of taxation, there may be little or nothing to distinguish the application from other applications drawn to business methods. Detailed scrutiny of the patent disclosure by someone having the relevant tax or accounting experience might winnow out investment method patents that would confer, but do not explicitly state, a tax advantage. But the Patent Office examination corps has little experience in such matters, and a given patent application typically does not undergo such detailed examination.

Alternatively, since the interpretation of the patent statute by courts and by the Patent Office has led to the "let it all in" approach to subject matter, there have been calls for Congress to intervene, at least with regard to tax shelter patents. (59) But legislation on the matter is probably neither feasible nor desirable. First, Congressional attention to intellectual property reform is at best sporadic and tenuous, as there is typically little collective incentive to address such matters--patent law seldom commands the attention of the electorate or the press such that an enormous amount of political capital is needed to muster the necessary votes. (60) At various times various constituencies have raised a hue and cry over a range of subject matters that they felt should be barred from patentability: gene patents, animal patents, software patents, and many others. (61) Despite what are often poignant and frequently compelling reasons to bar such patents, these efforts have seldom resulted in any concrete legislative action.