Question

A British pharmaceutical company spent several years and considerable funds on the development of a treatment for HIV patients. Now, with the protection afforded by patent rights, the company has the potential to reap enormous gains. The government, in response, has threatened to tax away any economic rents the company may earn. Is this a sensible policy? Why or why not? (Hint: Contrast the short-run and long-run effects of taxing away the economic rents.)

Short answer

Threatening to raise economic rent taxes may not be the best policy.

Step-by-step solution

Introduction

Threatening to raise economic rent taxes may not be the best policy. This government policy would result in a reduction in R&D spending.

Before investing in research and development companies analyze the potential returns. There will be little motivation for corporations to perform further research if the expected returns are going to be nil.

Explanation

Short-run economic rents encourage businesses to invest in research and development and to make the most efficient use of their resources. Firms examine the long-term profitability of investing in product development.