What is an Excess Profits Tax?
An excess profits tax is a special tax that is assessed upon individual or corporate income beyond a specified amount of return on invested capital, usually in excess of what is deemed to be a normal income. An excess profits tax can be implemented with the intention of reducing income inequality, redistributing windfall gains that may result from special circumstances or government policies, or generating emergency revenue for the government in times of crisis. Excess profits taxes may be temporary measures or a permanent feature of a tax system.
- An excess profits tax is an extra tax imposed on business profits or income above a certain rate.
- Excess profits tax can be temporary or permanent and are usually intended to offset income inequality, especially that due to windfall profits.
- In the U.S., excess profits taxes have repeatedly been imposed by the federal government during periods of war and other crises.
- In 2020, a federal excess profits tax was again proposed by Berkeley economists Emmanuel Saez and Gabriel Zucman during the coronavirus outbreak.
Understanding Excess Profits Tax
An excess profits tax is an extra tax levied on business profits or income above a specified rate of profit. Any companies or self-employed individuals who earn above the specified level have to pay an additional tax on that income. An excess profits tax is assessed in addition to any individual or corporate income tax already in place. In effect, an excess profits tax represents an increase in marginal tax rates on profits in higher tax brackets.
Because of this, an excess profits tax represents an increase in the progressivity of the tax system, by taxing higher income individuals and businesses at an even higher rate than normally imposed. They are sometimes advocated for this feature by economists and policy makers who are critical of income inequality in society. This tax is not popular with free-enterprise thinkers who feel that it discourages productivity by reducing the profit motive for businesses.
Excess profit taxes can also be imposed to directly redistribute windfall profits that result from random, extreme events. For example if construction supply companies are able to make higher than normal profits by charging higher prices in the wake of a hurricane, the government may consider implementing an excess profits tax on them, on the grounds that their higher profits are due to the random occurrence of the hurricane rather than to good business sense or management practices. The tax could apply to any increase in the rate of profit these businesses receive relative to normal times.
Alternatively, an excess profits tax may be imposed if the windfall profits are due to a deliberate government policy. For example, if a war breaks out and the government suddenly ramps up demand for munitions, then an excess profits tax could also be levied on ammunition manufacturers and suppliers of related raw material such as copper or lead to compensate for the increased rate of profit these businesses will enjoy as a result of increased government demand. In this case, the tax itself might be imposed on the difference between the amount of profit that a company generally earns during peacetime and the profits earned during times of war.
History of Excess Profits Tax
Congress enacted the first effective American excess profits tax in 1917 with rates ranging from 20 to 60 percent on the profits of all businesses in excess of peacetime earnings. In 1918, a law limited the tax to corporations and increased the rates. In 1921 the excess profits tax was repealed despite powerful attempts to make it permanent. In 1933 and 1935 Congress enacted two mild excess profits taxes as supplements to a capital stock tax.
During World War II, Congress passed four excess profits statutes between 1940 and 1943 with rates ranging from 25 to 50 percent. During the Korean War, Congress also imposed an excess profits tax, effective from July 1950 through December 1953. The tax rate at this time was 30 percent of excess profits with top corporate tax rates rising to 47 percent from 45 percent.
In 1991, some members of Congress attempted to pass an excess profits tax of 40 percent upon the larger oil companies as part of energy policy, but that effort was unsuccessful. Some activists have advocated for a peacetime use of the excess profits tax, but such proposals face strong opposition from businesses as well as some politicians and economists who argue it would create a disincentive to capital investment.
During the coronavirus outbreak of 2020, economists Emmanuel Saez and Gabriel Zucman proposed an excess profits tax on businesses who benefited from the effects of the epidemic and the government enforcement of related public health restrictions. Fears of the disease itself as well as imposed quarantines, business closures, shelter-in-place orders, and social distancing measures harmed many businesses, but also benefited some, especially web-based and remote services. Online shopping, cloud computing, remote business applications, media streaming services, and social media have all seen major increases in traffic and business volume as more people work, shop, and socialize from home over the internet.
At the same time, the federal government dramatically ramped up spending by passing a $2.5 trillion dollar stimulus package to offset the economic damage caused by the virus and the public health response to it. In order to help pay for the emergency spending and to help make sure that the windfall profits of those who have benefited from the coronavirus are shared with those who have suffered, Saez and Zucman proposed an excess profits tax.