Can a Firm’s Expected Marginal Tax Rate Exceed 100 Percent?

Abstract

The effects of a progressive marginal tax rate structure are examined when the base of the tax is a firm’s realized profit, which depends on the realization of a random variable and the firm’s choice of an output level. Even though the firm is risk neutral and the marginal tax rate on any realized outcome is in strictly less than 100 percent, it is shown that the progressive rate structure causes the firm to choose a lower output level than would be chosen in the absence of the tax. This result is in striking contrast to the choice neutrality of such a tax in a world of certainty. A novel reason for this is identified—namely, that uncertainty and the progressive rate structure generate expected marginal tax rates of 100 percent and higher.