Reuven S. Avi-Yonah is the Irwin I. Cohn professor of law and the director of the International Tax Program at the University of Michigan.

Burger King’s proposed move to Canada is just the latest in a series of “inversion” transactions designed to enable American corporations to reduce the taxes they pay to the United States. These increasingly common transactions have led some observers to question whether we need to tax corporations at all. For example, Greg Mankiw, President George W. Bush’s economic adviser, argues in The New York Times that the United States should abolish the corporate tax and replace it with a tax on consumption. Even liberal pundits like Matthew Yglesias have toyed with the idea, arguing that the current system only encourages businesses to try to game the political system.

This view, though fashionable, couldn’t be more misguided. We shouldn’t scrap the corporate tax—we should protect it by enacting the legislation proposed by Sen. Carl Levin (D-Mich.) and supported by the Obama administration. (An inversion is a merger of a U.S. corporation with a much smaller foreign corporation that results in establishing a new corporate parent in a low-tax jurisdiction, while the actual headquarters and most of the corporate business remain in the United States.) Levin’s legislation would effectively combat inversions by requiring, among other steps, that corporate managers actually move to the country to which they seek to move their nominal corporate residence. In almost all of the inversions so far, corporate managers have chosen to stay in the United States while establishing a nominal holding company overseas. Burger King, for instance, isn’t planning to establish a real headquarters in Oakville, Ontario, where its proposed acquisition Tim Hortons is based.


The main argument against taxing corporations is that the burden of all taxation ultimately falls on individuals and that because of the uncertainty involved in establishing which individuals bear the burden of the corporate tax, ordinary voters are misled into thinking the tax does not fall on them. This uncertainty makes the corporate tax popular among politicians because they can benefit from the fiscal illusion that its burden falls on “the corporation”—rarely a sympathetic victim—while, in reality, it is imposed on the voters. Corporations may be people, per Mitt Romney, but they don’t cast ballots—at least not yet.

Better, opponents of the corporate tax argue, not to tax legal entities at all. In addition, they claim the revenue from the existing corporate tax is relatively low in developed countries (typically less than 10 percent of total revenue) and it can easily be replaced by raising individual taxes by a small amount. Finally, they add that the corporate tax is very complicated and the transaction costs of trying to avoid it—all those fancy accountants—impose significant losses on the economy. Inversions are seen as a result of the United States having an overly burdensome corporate tax regime, which drives businesses and jobs overseas.

None of these arguments is convincing. There are three reasons the corporate tax should be retained: At $300 billion per year, it is a significant revenue source that cannot easily be replaced; it preserves the progressivity of the individual income tax by preventing the rich from parking their income in corporations; and it enables Congress to regulate corporate activities more effectively.

In making his case for a flat consumption tax, Mankiw writes: “Corporate tax inversions aren’t the largest problem facing the nation, but they are a reminder that a better tax system is within reach, and that only politics stands in the way.” Only politics! Yglesias, for his part, suggests raising the cap on payroll taxes. Both are fantasies. Individual income tax rates are already quite high (over 50 percent in some states) and raising them further would be quite difficult politically, with broad opposition expected from all Republicans and many Democrats. Enacting a VAT, as Mankiw proposes, would face even more opposition from Republicans (because it is a new tax) and Democrats (because it is regressive).

The corporate tax, moreover, helps keep the individual tax progressive, because in the absence of the corporate tax rich individuals would be able to park their money in corporations and obtain indefinite deferral (i.e., not pay tax until there is a dividend distribution or a sale of the shares). In the case of “closely held” entities, such as Hobby Lobby, it is possible to overcome this problem by treating these entities as pass-throughs and taxing their owners on the income earned by the entity. But this solution will not work for publicly traded entities because of the difficulty of establishing who their shareholders are at any given moment. Thus, in the case of publicly traded entities, the corporate tax is still a way to make sure that rich individuals are not able to reduce their effective tax rate by delaying the payment of tax until a dividend is distributed.

There’s also a broader societal reason we need the corporate tax. Corporations are such important actors in any modern economy that the ability to regulate their behavior is crucial to achieving economic goals, and the corporate tax has since its inception been seen as an important vehicle to regulate corporate behavior. The tax can provide disincentives for behavior that Congress deems to be undesirable (e.g., paying bribes or participating in boycotts) and incentives for desirable behavior (investments incentives, hiring incentives, clean energy incentives, etc.). A lot of the complexity of the corporate tax stems from these “tax expenditures”—or, if you prefer, “loopholes.” Some of these goals can perhaps be accomplished by direct regulation and some by paying subsidies, but there are cases where tax is a more effective vehicle for regulation than either command-and-control regulation or subsidies. For instance, a carbon tax—which would fall on corporations—would be a far more efficient way of combating climate change than a cap-and-trade scheme.

It is certainly true that the corporate tax is too complicated, and that its current rate of 35 percent is too high—the highest rate among our major trading partners, as reform advocates repeat ad nauseum. But the solution is not to abolish the corporate tax. Instead, we should reduce the rate to 25 percent, and make up the lost revenue by abolishing unnecessary corporate tax expenditures such as accelerated depreciation, the subsidy for domestic “manufacturing” and the deferral of tax on the offshore income of U.S.-based multinationals. At the same time, we should protect the corporate tax base by enacting robust anti-inversion legislation. That kind of tax reform would both take away some of the incentives to invert and prevent large U.S. corporations from avoiding a reasonable tax on their income. And with both parties keen to tackle this problem, it’s a much more politically viable option, too.