Why an 80% Corporate Tax Rate Fails, Even in Theory   Recently updated !

Reuven Avi-Yonah proposes transitioning the U.S. corporate tax system toward a destination-based cash flow tax (DBCFT). While this base reform offers clear improvements, Avi-Yonah incorrectly concludes it justifies raising the top corporate tax rate to 80% on profits over $10 billion.

While full expensing reduces tax-driven distortions, it does not make high tax rates harmless.

Key Takeaways

• The Core Argument for High Rates: Under standard economic models, full expensing sets the present value of tax deductions ($z$) to $1$. In the user-cost-of-capital equation $c = \frac{r + \delta (1 – \tau z)}{1 – \tau}$, setting $z = 1$ reduces the formula to $c = r + \delta$. Because the tax rate ($\tau$) disappears, theory suggests tax rates no longer influence marginal investment decisions.

• Why Real-World Taxes Depart from Theory: The standard framework assumes symmetric tax treatment—meaning all costs are fully deductible when incurred and all losses yield immediate refunds. In reality, tax systems are asymmetric:

  • Uncompensated Entrepreneurial Effort: Founders often invest sweat equity (unpaid labor). Because this opportunity cost cannot be deducted as a business expense, raising the business tax rate directly inflates the required pre-tax return.

  • Loss Limitations: Startup deductions are delayed or lost if a business never turns a profit—a common outcome where over half of venture-backed startups fail.

  • Progressive Rates: Taxing early expenses at a low rate (e.g., 21%) while taxing eventual gains at a top rate (80%) distorts capital allocation over a firm’s lifecycle.

Non-Linear Costs of Rate Hikes

Departures from perfect expensing mean that rate increases become progressively more damaging as the base rate rises:

Reforming the tax base toward a DBCFT reduces profit shifting and lowers the cost of moderate tax rates, but it cannot offset the severe economic distortions of an 80% marginal rate.