California dominates America’s intellectual property creation landscape, with 45,683 patents granted to California-based people or firms in 2017, 27.3% of the patents assigned in the 50 states and D.C. In 1992, California accounted for 15.5% of the patents granted in America.
California accounted for 12.1% of the nation’s population in 1992, so, its 15.5% share of patents was only slightly above its proportion of the national population.
A quarter-century later, California still accounts for 12.1% of the U.S. population, but its share of intellectual property generation has surged to more than double its share of the population.
How California came to be America’s high-tech powerhouse is tied up in the decline of its once-robust defense and aerospace industry, easy access to capital, and its world-class university research network.
How California may lose its high-tech dominance comes down to two factors: high taxes and rampant Chinese intellectual property theft.
In 1987, at the height of the Reagan-era defense buildup, California accounted for 1 in 4 aerospace jobs in America. But, as the Cold War between the U.S. and the former Soviet Union sputtered to an end with the fall of the Berlin Wall in 1989, California’s vast aerospace and defense industry struggled to adapt. Wave after wave of layoffs and consolidations, mergers and acquisitions, and shifts of manufacturing away from high-cost California to Texas, Florida and other lower-cost states led to a hemorrhaging of aerospace jobs.
Silicon Valley soon supplanted California’s defense industry, generating a tremendous amount of wealth, even if the number of jobs wasn’t as great as the military equipment manufacturing it replaced.
Regarding tax revenue, the commercial high-tech industry has been a particular boon to California government. With the highest corporate tax rate west of the Mississippi among the contiguous 48 states, 8.84%, and the highest marginal individual income tax rate in the nation, 13.3%, California rakes in the money from its homegrown technology sector. For example, in 2012, Facebook’s initial public offering was projected to bring in $2 billion in tax revenue to the state of California—about 2% of its tax revenue that year.
But people, like ideas, can easily cross political boundaries.
Gil Hyatt, who began his career in the early 60s with Teledyne, an electronics manufacturer and defense contractor, invented key foundations of modern integrated circuits, receiving a patent on his intellectual property in 1990. As he prepared to cash in on his hard work and brain power, he moved from California to Nevada in 1991. Nevada has no corporate or individual income tax.
Immediately, California’s tax officials moved to claim their share of Mr. Hyatt’s invention. By 2017, after 24 years of fighting it out in court, a $13.3 million state tax bill had grown to more than $55 million in taxes, penalties and interest with the case making it to the U.S. Supreme Court twice. Facing an embarrassing loss, California threw in the towel after spending more than $25 million to pursue Mr. Hyatt’s money across state lines and make a very public example of him.
In response, Gil Hyatt, 81-years-old, sued California. A jury in his home state of Nevada backed him up with a $400 million award against California, though the amount was subsequently reduced to $1 million by the Nevada Supreme Court. Now the U.S. Supreme Court has agreed to review Mr. Hyatt’s case a third time, looking into how the Constitution’s Full Faith and Credit Clause applies to interstate tax disputes involving individuals.
The stakes for California couldn’t be higher. Mr. Hyatt’s win after two dozen years in court may point the way for other inventors and technology entrepreneurs to realize their gains out of state. Of the top ten states for patent awards in 1992, only two besides California gained in their national patent market share: Texas and Massachusetts. Texas doesn’t tax personal income or capital gains while Massachusetts' tax on income and long-term capital gains is only 5.1%, less than half of California’s top marginal rate.
Washington State has seen a 168% increase in its patent grant market share since 1992, the highest in the nation, and enough to move it from 16th to 5th in total patents by 2017. Washington, home to Microsoft, has no individual or corporate income tax.
The threat from China to California’s intellectual property engine is harder to gauge but no less urgent than the recent court loss to Mr. Hyatt.
In 1992, the People’s Republic of China was granted 41 patents by the U.S. Patent and Trademark Office (USPTO), more than were granted to residents of Wyoming, 34, but fewer than were granted by residents of South Dakota, 43. By 2015, that number swelled to 9,004, just under number two Texas and number three New York.
Significantly, the patents granted by the USPTO to Chinese entities largely represents inventions originating in China—it does not account for what a 2017 report by the United States Trade Representative estimates as $225 billion to $600 billion a year in intellectual property (IP) theft via cyberattacks and forced technology transfers as a condition of access to Chinese markets. Much of this theft is committed by Chinese industries, many of them state-owned and controlled, in a concerted government effort known as the Made in China 2025 initiative.
At $600 billion a year, the IP losses to California-based industry could be on the order of $164 billion a year, given the state’s ongoing dominance in patent grants. The lost tax revenues for California alone could be greater than $10 billion annually.
More importantly, given California’s status as a high-tax, heavy-regulation state, it increasingly finds its comparative advantage in IP, whether in high-tech, biotech or Hollywood. China’s targeted IP thievery directly threatens California’s strongest asset. As such, California’s political leadership should consider declaring a truce with President Trump—if only on the issue of halting Chinese intellectual property piracy.
This commentary was originally featured in Forbes on August 20, 2018.