Decreasing returns, patent licensing and price-reducing taxes

This paper proposes simple tax policies that can alleviate the distortive effects of royalties. We consider a Cournot duopoly under decreasing returns where one of the firms has a patented technology that it can license to its rival using combinations of royalties and fixed fees. Under optimal licensing policies for the patentee, stronger diseconomies of scale result in lower market prices. It is possible to construct tax-transfer schemes for the firms that are Pareto improving as well as deficit neutral, i.e., these taxes lower market prices and collect sufficient revenue to compensate firms for their losses from taxation without incurring any deficit.