In the shifting landscape of global economic policy, a new intellectual current has emerged: the belief that if a government sufficiently "fixes" its tax base—particularly through the implementation of full expensing and anti-profit-shifting measures—it can essentially decouple corporate tax rates from economic harm. This argument has found a prominent champion in legal scholar Reuven Avi-Yonah, whose forthcoming article in the Tax Law Review, titled "Taxation and Deglobalization," posits that after specific structural reforms, the traditional economic fears associated with high corporate income tax (CIT) rates would become obsolete. Avi-Yonah goes so far as to entertain a top marginal rate of 80 percent on high-profit corporations.
However, a rigorous examination of economic theory and the realities of business investment reveals that this perspective is deeply flawed. While broadening the tax base is a laudable goal, the notion that such reforms render the corporate tax rate irrelevant to economic growth is a dangerous oversimplification that ignores the fundamental nature of investment, risk, and the "sweat equity" that drives modern innovation.
The Chronology of a Policy Debate
The debate over the relationship between tax bases and tax rates is not new, but it has gained urgency as policymakers grapple with the rise of multinational digital giants and the erosion of traditional tax revenue.
- The Early 2000s: Economists began focusing on the distortions caused by profit shifting, where multinationals exploit the gap between high-tax and low-tax jurisdictions to lower their effective tax burdens.
- The Rise of Full Expensing: In recent years, scholars and policy institutes—including the Tax Foundation—have championed "full expensing" as the gold standard for pro-growth tax reform. By allowing firms to immediately deduct the full cost of capital investments, the tax code stops penalizing businesses for growing, boosting productivity and wages.
- The Current Pivot: Prominent analysts, including Kimberly Clausing, Jason Furman, Michael Linden, and Samantha Jacoby, have explored variations of "fix the base, raise the rate." Their work generally advocates for closing loopholes and broadening the base to allow for a higher, yet stable, corporate rate.
- The 80 Percent Proposal: Avi-Yonah’s recent work represents the extreme edge of this trend. By grounding his argument in the concept of "deglobalization," he suggests that if a nation has enough market power, it can impose massive tax burdens on the most profitable firms without fearing capital flight.
Theoretical Framework: The User Cost of Capital
To understand why the 80 percent rate proposal is economically unsustainable, one must look at the Hall-Jorgenson framework, the standard economic model for investment decisions. Investors generally undertake a project only when the expected pre-tax return exceeds the "user cost of capital."
In a simplified world, full expensing (where the present value of cost-recovery deductions, $z$, equals 1) causes the tax rate to drop out of the investment formula. This leads to the seductive conclusion that if $z=1$, the tax rate is irrelevant. But this model assumes a "frictionless" world that does not exist.
The Problem of "Sweat Equity"
Real-world investment often involves inputs that the tax code cannot easily price or deduct. Consider the entrepreneur who works for years for below-market wages to build a startup. This "implicit wage"—or sweat equity—is a significant investment cost. Because the tax code does not allow a deduction for the opportunity cost of an entrepreneur’s time, the tax rate continues to distort the decision to invest.
When the tax rate is low, this distortion is manageable. However, as the rate climbs toward 80 percent, the math changes drastically. Mathematical modeling shows that raising the business rate from 21 percent to 80 percent increases the required pre-tax return on investment by roughly 114 percent. At such extreme levels, even a theoretically "perfect" tax base cannot mask the crushing weight of the tax rate on new firm entry and innovation.
Supporting Data: Why Rates Still Matter
The economic evidence suggests that the "base vs. rate" debate often misses the nuance of firm behavior.
- Symmetry and Loss Positions: The standard model assumes that if a firm pays tax on profits, it receives an equivalent benefit from deductions on losses. In reality, startups and venture-backed firms often operate in a loss position for years. If a business fails—as 55 percent of venture-backed startups did between 1985 and 2009—the tax benefit of the "expensing" deduction is never fully realized.
- Asymmetric Treatment: Avi-Yonah’s proposal for a progressive rate structure (up to 80 percent for profits over $10 billion) introduces intertemporal distortions. If a firm’s early costs are deducted at a lower rate, but its later successes are taxed at 80 percent, the "effective" tax burden on the project becomes prohibitive. This penalizes the most successful innovators precisely when they reach the scale that drives the modern economy.
- Profit Shifting vs. Real Investment: While reforms like a Destination-Based Cash Flow Tax (DBCFT) are excellent at curbing profit shifting by denying deductions for imports and exempting exports, they do not resolve the issue of domestic capital formation. Reducing the incentive for companies to move their headquarters is not the same as encouraging those companies to invest more in new technology and research.
Official Responses and Expert Counterpoints
The proposal for an 80 percent corporate rate has drawn sharp criticism from economists and tax policy analysts who argue that such a move would be self-defeating. Kyle Pomerleau, a senior fellow at the American Enterprise Institute, has consistently argued that a high corporate rate hike is fundamentally unwise, regardless of the base.
The consensus among market-oriented economists is that while fixing the base is essential to prevent distortions, the rate itself acts as a "price" on capital. Even if you make the tax system more efficient at collecting revenue, a price of 80 percent on capital is essentially an invitation for capital to move elsewhere, regardless of the regulatory hurdles of "deglobalization."
Implications: The Dangers of "Rate Blindness"
The danger of the current intellectual climate is that policymakers may be tempted to view the tax base as a "magic bullet." If they believe that "full expensing solves everything," they may feel emboldened to ignore the empirical reality of how tax rates affect business decision-making.
The Risk of Stagnation
If the United States were to implement an 80 percent rate, the immediate result would likely be a dramatic decline in domestic R&D spending and a shift in venture capital toward jurisdictions with more rational tax regimes. Even if the tax is theoretically designed to target "monopoly rents," the market has no perfect way to distinguish between a company that is successful because of monopolistic behavior and a company that is successful because of superior innovation and efficiency.
The Erosion of Neutrality
Progressive corporate tax rates, by definition, punish scale. In a global economy, scale is often the only way to compete. By creating a tax system that aggressively targets large, high-profit firms, the government would be creating a "ceiling" on growth, effectively forcing firms to either cap their domestic operations or reorganize in ways that are economically unproductive simply to avoid the 80 percent threshold.
Conclusion
Reuven Avi-Yonah’s contribution to the Tax Law Review serves as a fascinating thought experiment, but it fails to account for the fundamental economic reality that tax rates and tax bases are not mutually exclusive. While it is true that we should move toward a more efficient, less distortionary tax base—perhaps by moving toward something resembling a destination-based cash flow tax—it is a grave error to assume that these reforms provide the political cover for confiscatory tax rates.
The tax rate is the primary signal for capital allocation. When that signal is distorted by an 80 percent rate, no amount of base-broadening can prevent the resulting economic damage. True tax reform requires a balanced approach: one that broadens the base to ensure fairness and efficiency, while keeping rates at a level that encourages, rather than punishes, the engines of economic progress.
